BOXX: Access Options Funding Rates in an ETF

In the last week of 2022, Alpha Architect launched the BOXX etf. Depending on your needs, it is a promising alternative to T-bills – but the thing that’s so cool — BOXX is doing the same trades option traders do to manage their cash!


In the summer of 2022, I watched an episode of Show Us Your Portfolio, where professional investors discuss how they personally invest. This episode featured Wes Gray the founder of Alpha Architect.

  • How I Invest My Own Money: Robust to Chaos (blog post)

    After appearing on the show Wes actually wrote out an in-depth blog post explaining how and why he invests the way he does. Notice the thoughtful appreciation of his constraints and goals, then see how he matches them with a portfolio.

I’ve gotten to know Wes over the years and found his framework deeply resonant with my own thinking. I called him to discuss certain aspects of it in more detail.

While discussing the portfolio, he told me about the upcoming BOXX ETF knowing I’d geek out on the options bit. Not to mention that the ETF is sub-advised by former colleagues from my SIG days.

Now that the ETF has been on the market for 9 months and garnered a critical mass of assets (>$400mm AUM), I feel comfortable explaining how it works. Before I get to that let’s discuss the value proposition to investors.


The attraction here is straightforward, tax-efficient cash management:

You will understand why it’s t-bill risk and t-bill return without actually holding t-bills when we walk through the mechanics of its trade. But the thing that should pop out at you is:

You can get this type of product in an exchange-traded format –an ETF. So you don’t pay taxes until you sell (unlike mutual funds), you can hold the ETF in a vanilla brokerage account or tax-advantaged account like an IRA or 401k (if your plan allows it). You could even use it as one of the components in an automated ETF rebalancing program like you can build with Composer.

I’m going to pause here because I don’t want to rehash research that is already well-done. Nomadic Samuel wrote a great explainer of the ETF:

BOXX ETF: Review Of The Strategy Behind Alpha Architect 1-3 Month Box ETF (Picture Perfect Portfolios)

There’s a section of the explainer I want to zoom in on:

Well, the Moontower reader is gonna understand how this thing works in a moment. A “box” trade is covered on day 1 for option brokers and trading trainees.

How Box Trades Work

Before my additions, I’ll point you to Wes’ in-depth explanation of box spreads:

Box Spreads: An Alternative to Treasury Bills? (Alpha Architect)

This is a great option explainer. He walks through it just like I would.

  1. Shows that buying a call and selling a put on the same strike is a synthetic future position. Just think of it this way…if you buy a 100-strike call and sell a 100-strike put in the same expiry month, then at expiration, no matter what happens, you will buy the stock for $100!


    • If the stock is above $100, you exercise the call
    • If the stock is below $100, you get assigned on the put
  2. If you buy the synthetic future with a $100 strike and short the synthetic future with the $110 strike you will make $10 at expiration with certainty, you have locked in $10 at expiration. Of course, the cost of such a payoff today is not zero…that would be free money.
    The cost of a riskless $10 in say 1 month’s time is just the present value of $10.

    Think of a t-bill. A t-bill is just a zero coupon bond that says at maturity you receive $10. You might pay $9.95 for that today. You will make $.05 profit guaranteed for outlaying $9.95 today.

    This implies a yield or T-bill rate of .05/9.9 = .5% (or an annualized 6%)
    A box is the simultaneous buy and sell of synthetic futures for the same expiration date with different strikes. The difference between the strikes is like the face value of zero-coupon bond.

    The premium you pay for that expiration payoff implies the yield to maturity, the same way the price you pay for a T-bill implies the rate you receive.

Wes’s more detailed explanation with my highlights:

Wes reiterates the entire basis of Law of One Price which stipulates that 2 instruments with the same cash flows will offer the same return in present value terms.

My old professor, Dr. Eugene Fama, is sure markets are efficient. And if two assets earn a similar return, it must be the case that the risk of these two assets is very similar. And now that we’ve determined that box spreads earn similar returns to treasury bills (often higher!)

“Often higher?”

Wes drops a hint — the box rates are often higher than the t-bill rates.

This isn’t crypto land where you can just say anything you want. Wes is operating in a highly regulated SEC compliance environment. You don’t overpromise. And he doesn’t need to — if box rates and t-bill rates lined up perfectly the value proposition of the ETF still shines through.

But this is where my experience can add some color. I’m not surprised the box rates are higher.

“Kris, why would the box rates be higher?”

When you study options pricing and Black Scholes you learn that the risk-free rate is used to discount the payoffs to present value. In practice, options market makers don’t just deal with a single rate. There are at least 4 rates that matter:

  • Stock long rate: the cost to finance long shares
  • Stock short rate: the interest you receive on the cash raised by a short sale. Sometimes referred to as the “rebate”. In hard-to-borrow stocks you often pay interest to be short!
  • Option long rate: The cost to finance option premium that you’ve outlayed
  • Option short rate: The interest received on debit option balances

The clearing firms that custody and finance trading accounts are for-profit businesses — they earn a spread on the long rate vs the short rate. Same as banks.

In general:

  • the cost to borrow money is going to be the SOFR rate + the clearing firm’s margin
  • the interest received on cash balances is the T-bill rate – the clearing firm’s margin

SOFR rates are derived from overnight loans collateralized by Treasuries, therefore they trade very tight to t-bill rates. The bulk of the financing spread is simply the clearing firm’s margin.

If t-bill rates are 6% and the clearing firm’s margin is 50 bps per side, then the clearing firm is willing to lend to the trader at 6.5% and pay 5.5% on cash balances.

The key insight: Market makers cannot freely borrow and lend at a single risk-free rate as theory assumes

At any given time there is likely some market maker that is cash-heavy and earning say 5.5% while another is paying 6.5% to finance long share or option positions. The box market is a way for them to increase or decrease their cash balances! If you are long lots of option premium and paying 6.5%, you can sell a box spread which allows you to lay off premium in exchange for cash. You might sell that $10 box for $9.95 effectively borrowing cash knowing at expiration you will owe $10.

This is smart — you are refinancing your position from paying 6.5% to the clearing firm to borrowing from the options market for 6%!
The point is that there is no real voodoo here — boxes allow market makers to re-finance their positions with each other effectively cutting out the banks.

If the rate prevailing in boxes is typically higher than the t-bill rate that tells you that the options world is a net owner of shares/option premium because the box rate is clearing at a slightly higher rate than t-bills imply.

I have mentioned that so much of options trading is not fancy ideas but mundane business considerations. Like keeping your financing under control. Boxes and their siblings, reversal/conversions, have active liquid markets. There are brokers who deal in them all day. At a large enough options shop, there is a trader who deals in them all day. It’s analogous to the treasury department at a bank, charged with minimizing funding costs.

The BOXX ETF is a legitimate innovation allowing non-option investors to buy box spreads. This allows them to lend at box rates. To supply liquidity to the options market which is a net borrower.

  • Funding spreads aren’t necessarily 50 bps per side. It depends on the client’s riskiness and how big an account they are. When I had a small private backer the funding spread was multiples of the funding spread I had at SIG or the hedge fund. The wider your funding spreads, the more inclined you are to trade box spreads so you can tap into the market rate and cut out the clearing firm’s margin.
  • Your counterparty in box trades is the exchange clearing house. These are very strong credits. You face that risk any time you trade options. Wes addresses that in his article.
  • BOXX holds European-style options so there is no early exercise risk.
  • BOXX is tax efficient. In fact, it can be more efficient than owning state-tax-exempt t-bills but this is something for you to work through with an advisor. It depends on your specific situation.
  • In general, derivatives markets, governed by the invisible hand of intense arbitrage pressures embeds funding rate very close to Fed Funds (ie short term t-bills) rates. When you buy an SP500 futures contract you are getting leveraged exposure since you only need to post cash margin at a fraction of the full notional value. This inherently levered position means you are borrowing. However, it is the most cost-effective form of borrowing because the rate is inherited from arbitrage by the most well-capitalized traders who can afford to lock in risk-free profits with the smallest possible margins. The team at Return Stacked Portfolio Solutions wrote a simple explainer post reviewing the mechanics — The Cost of Leverage

Extra for Option Masochists

It’s hard to overstate just how deeply tied funding concerns are to vol trading.

If my stock long rate is much higher than yours then calls will have a lower implied vol to me than to you. Likewise puts will look more expensive than you. If I had a long stock position I’d want to swap it for a long synthetic futures position by doing a “reversal” (buy call, sell put, sell stock). If my rate was much lower than the market I’d want to “convert” (sell call, buy put, buy stock).

See You Think You’re Trading Vol…But Are You Even?

Every option trader has used revcon.xls to price the exact carry on a position down to the T+1 settlements for options and T+2 for stock. They’d be counting days like fixed income traders.

Box spreads are the simplest arbitrage identities in the options market. They are the basis of figuring out what a put spread is worth by knowing the call spread value.

BOXX is a really neat product allowing equity investors to tap into the borrow/lend markets that were once fenced off to option participants. And the option participants are happy because an already deep market is getting deeper.

On Active Management and Private Investments

Suppose you go to a brick-and-mortar coin dealer in your town and buy some gold. How confident are you that it’s real?

Pretty confident, I’d guess. You should be. By having a shop with non-negligible overhead and in-person transactions the dealer is signalling trustworthiness. Plus some percentage of the customers are going to be paranoid doomers who will assay a sample for purity. If it’s fool’s gold, there’s a good chance they’ll raise hell on Nextdoor and the dishonest dealer will lose business.

In asset management, the valuable thing to be mined is alpha. Consistent outperformance for a given level of risk. A true edge. Mining for alpha is conceptually similar to mining for gold. For a given extraction price there’s a limited supply. Part of that extraction price includes a return hurdle — there must be a profit margin to make the effort worthwhile. This is why markets will never be fully efficient and are said to be efficiently inefficient. 

However, spotting fool’s gold in active management is definitely not straightforward. Track records are prone to survivorship bias — if you flip 10,000 coins and keep the ones that turn up heads, about 10 coins would remain after a decade. You still wouldn’t “hop on a call” with these coins. The problem is even more diabolical. The shrewdest investors are usually well-resourced. They are like a metallurgy expert who would have separated the real stuff from the fool’s gold before you get a look. And since there’s some probability that the alpha is fake, investment fees should clear at a level that discounts the probability that it’s fake. No star manager is selling their alpha in a 40-Act fund (this is a basic “market for lemons” argument).

This is a stylized equilibrium. There are exceptions but the burden of proof is on the promoter. Remember, alpha is zero sum — there must be losers for there to be winners and if you don’t have a good reason for why a winner wants your money then you’re tossing rings at a carnival. You’re gonna spend $50 to win a $5 panda that you’ll throw out in a week. Worse yet, you won’t throw the investment out, you’ll just keep paying for its upkeep while it sheds lint all over your portfolio.

Byrne Hobart, recounting some amusing research, states how reality differs from the equilibrium (emphasis mine):

Chengyu Bai and Shiwen Tian have a study showing that more attractive fund managers get promoted faster but have worse returns . A good model of asset management is that skilled managers gather assets until their fees roughly equal the alpha they generate. It’s not a stable equilibrium for someone to be able to get rich by passively moving money out of an index fund and into an active manager’s fund, and managers like having money. So, in general, skilled managers raise more money (or charge higher fees) until their after-fee returns approach what someone could get elsewhere. Unskilled or unlucky managers find a different line of work. But this model describes an asymptote, not the state at any point in time; even if it’s true, there will be some emerging managers who are putting up good returns but not getting enough credit for it, and others who either have a good pitch or a lucky year or two and can over-raise accordingly. (And, of course, some managers are not purely money-motivated, and keep their firm at a size that’s appropriate for whatever they like most, whether that’s turning over lots of rocks in nanocap stocks—a rewarding activity at the moment!—or funding private companies that are barely past the idea stage.) If there’s some factor that makes it easier to raise money (being good-looking can keep you out of jail for longer, so it makes sense that it would apply in other places), then those managers will raise more than they should. The good news for anyone who isn’t strikingly attractive but does want to make money in investing is this: alpha only exists if there’s someone worse than you on the other side of the trade, so beauty bias in fundraising means better returns for everyone else.

In the equilibrium version, managers with alpha choose their investors strategically for some synergistic benefit OR they charge fees that slide most of the alpha money to their side of the table. As Byrne says, that equilibrium is an asymptote that we never quite arrive at. Some managers are overearning while others are underrecognized and underearning compared to the value they create.

This is also why the general rule of long investor letters quoting Roman emperors are bad signs. True killers don’t ramble and only move at night. Of course, a star doesn’t just emerge a killer, he or she arrives there. So identifying one before they reach the height of their bargaining power can be a lucrative trip (if you can find them before the pods do)

I could just invoke the Yogi Berra “I don’t want to be part of any club that’ll have me” line and if readers internalized that they’d save themselves some fees as well as the inevitable “are these just sugar pills” moments of doubt.

But there’s always some overachiever who believes the wire that binds effort to outcome in a low-signal process is tighter than it is. Let me offer some thoughts.

Heuristics for Choosing An Active Manager

In the cheeky article Proprietary Trading: Truth and Fiction, notable quant Peter Muller drops an evergreen table:

As a basket, those managers penning flowery investor letters quoting Roman stoics would be nice candidates for the short leg of a strategy (there should be a borrow market for private LP stakes. That might even make Twitter fun again). When I look up the website for a firm and find a landing page from 1998, that’s exciting. Lowkey goated.

That said, animal spirits are a thing and junior killers might want to have their name on the door regardless of how much their employers offer them. When they go out on their own there’s a small chance you cross paths with them before they reach the height of their bargaining power.

Potential Drawbacks of Private Investments


Public markets benefit from transparency. Law, regulation, and customs contain recourse and precedent. Boards are accountable. Reputations matter. There are blemishes but considering how much money and risk are regularly trafficked in modern capital markets you would expect some error.

Private markets are caveat emptor. Trust is a matter of transparency and alignment which go hand-in-hand. Even with a rigorous diligence process professional allocators can find themselves bamboozled. Now move down the chain. If a syndicate is corralling small retail checks on the internet, it’s worth asking some questions that go beyond strategy and performance.

  1. Am I a client or just a customer? How valuable is this relationship to the GP? An extreme example of this is the crypto staker — an anonymous source of capital in a murky market. Illegal immigrants are easy targets for scammers because what are they going to do? Call the cops? You can see the parallel.
  2. What’s the extent of principal-agent problems or conflicts of interest? Does the GP own a brokerage firm as an outside business? Is your PE manager raising a fund to buy stakes in its other funds? Too obvious? What if PE funds raise money to buy stakes from other PE funds, but they all started doing this? When I was in the pits, floor brokers were allowed to trade for their own accounts but not against their own orders. So you know what happens? The brokers show the juiciest orders to other brokers first before showing the market-makers. And what do you think will happen when those other brokers get a juicy order? Again, you should see the parallel.
  3. Why did they find me instead of raising institutional capital? The answer to this doesn’t need to be nefarious. Institutional capital is expensive to raise both from a box-checking/pedigree point of view and the nature of long sales cycles for large checks. They can also be demanding LPs whose rigid discipline might be meddlesome and misguided. (That said, the best institutional LPs, perhaps rare, can actually level up a manager by sharing practices they see in other funds and generally being insightful). But if the syndicate that found you just sees you as a cheap source of capital, you’d want to know that. If their primary skill is audience-building then the most tempting monetization path can be to raise a bunch of money and flip a coin. You don’t want your GP’s superpower to be gathering eyeballs when they’re supposed to be investing.
  4. Here’s a wonky one. You are an investor in a fund that charges 2%. Would you rather they ran the strategy at 30% volatility or 15% volatility? The answer is you’d rather they run the strategy at the higher volatility and you allocate half as much. Your proposition is unchanged but you pay half as much in fees. The GP prefers you don’t understand this. There’s a similar misalignment for traders and portfolio managers who do not get a percentage of the total firm p/l but get paid on their individual p/l. Those traders are equivalent to LPs. They want maximum volatility and little diversification because their compensation is a call option. If the firm is diversified, the trader faces “netting risk” where they might make money but another part of the firm loses money. The GP collects their fee and there’s no net return to pay the winners. This is the “basket of options is worth more than an option on a basket” idea. In this example, the trader and the LP are in similar positions and neither is fully aligned with the GP.

I don’t mean to make you feel like private investments are spellbound by dark arts. These issues are usually not issues — until times get tough. But that’s when you care the most because of the next topic.


Private investments are less liquid. Lockups, redemption notice periods, possible gates. Depending on the strategy much of this is unavoidable. But illiquidity is brutal. It hamstrings your ability to rebalance and tax-loss harvest.

Behavioral arguments for tying up your money as forced savings or “protecting you from yourself” are overfit, ignorant of counterfactuals, and coincidentally convenient to the people who promote them. The cost of illiquidity is visible and confirmed by market prices (on-the-run vs off-the-run Treasuries). Liquid collateral literally earns you a lower cost of funding. If you want to get nerdy about it see How Much Extra Return Should You Demand For Illiquidity? where I offer at least a qualitative framework for how to value it as an option.


What if the private investment goes well? Is this the equivalent of beginner’s luck in blackjack? Did you learn anything or just gain confidence?

When performance slides it’s hard to foresee how the manager will respond. They are below the high watermark, is the morale low? Are employees quitting? Bad times will come. Are you going to stick through them or add more?

In Repetition Economics, I frame the problem in the context of another industry oozing with snake oil:

If you start taking vitamins, do you have a plan for determining if they are “working”? Or have you signed up for a perpetual liability with an unclear benefit?

Gary Basin explains this concept more broadly in Action Echoes:

Rather than seeing this temptation as a one-off event, view it as repeating over and over into the future. Imagine the decision you make this next time also deciding how you act in similar future situations. Your actions echo into the future. Every “bad” move has consequences later in the game. Sure, you can sometimes find ways to dig yourself out of a hole. But it’s helpful to realize that every move you make contributes to your eventual position.

Reframing a decision as a bundle of future repeated actions gives a more accurate view. The goal is not to entirely avoid urges but to reframe them in a way that best accounts for their consequences. Any single temptation is not unique! The actions you take now will establish patterns that determine your future.*

Private investments are partnerships with people. You are subscribing to some very difficult future decisions when you write that check. When we add up all these drawbacks, the reasons to step out into the world of privates need to be incredibly compelling. With all these Family Feud X’s buzzing your accredited investor dreams I suppose it’s only fair to discuss some of the benefits.

Benefits of Private Investment

True Differentiation

You are invested in a business; not stock pickers

This is the holy grail. You get access to a strategy that is nothing like beta. If it acts like beta but simply outperforms it’s hard to size up because of its correlation to the rest of your portfolio and probably your employment. But if you find something that poses as an investment but is actually a business oscillating between making steady money and occasionally tons of money then you found the thing worth blasting through all the orange cones for. It’s only a matter of time before the world catches on to your discovery, but if you take a chance on the team early, they will reward you by not pushing you out as they grow.

The approach here is looking for quirky stuff where the team is strong but for any number of reasons are unable to attract the attention of suits and have no interest in soliciting the masses.

Authentic diversification

There are assets that are overpriced on a line item basis but because they are uncorrelated with beta that can improve an overall portfolio (vol, commodities). You will tend to notice massive dispersion in the returns of the active managers in those classes. This means there’s space on the field for them to justify their fees by being skilled players and having relationship moats. [It also means there isn’t a benchmark that anyone cares to hug because the benchmark itself has a tenuous grip on anything relevant to mainstream investment thinking. Start explaining a managed future benchmark to an equity investor over drinks and they are definitely answering the staged bail-out call.]


In How I Misapplied My Trader Mindset To Investing, I wrote:

I appreciate that people can find an edge in their respective domains. I was spoiled by trading. Expiration cycles, large sample size, and a lack of beta meant edge, positive or negative, reveal you faster. Investing is a more wicked domain. My default belief is still that edge is rare and mostly unavailable to me. Storytellers can hide in the randomness and low signal-to-noise. And I’m not fully immune from them anyway. Still, I believe if you filter well, the number of times you get burned will just be the cost of doing business. Any private investment has to satisfy my doubt as to why I should be invited. And once invited, I am mostly judging character and ability. This is admittedly an act of faith. I’m pattern-matching to successful traders I’ve seen. I’m comfortable betting on people. Not because I even know if I am good at this, but because I think there are more ways to fail forward. If I constrain my risks at the sizing level I can more easily enjoy the positivity that emerges from partnering, helping, and believing in one another. It’s more holistic than a spreadsheet.

In a recent interview with Meb Faber, Ted Seides articulated my wife and my feelings exactly:

Most of the [private] investments are actually people that I’ve known for a long time. I don’t have investments with the big brand-name people. Part of that, for me, is an angle on active management, and certainly, this style of active management that I think is completely lost in the active-passive debate, which is the relationship aspect of it. Because I can give money to a manager, and yes, I will get the returns that come from that, but who knows what else is going to happen, both potentially financially and also just in life, right? There’s so much optionality that comes from having great relationships with people. It’s one of the reasons why it was easy for me to have a bias towards sticking with managers. I can’t stand ending those relationships with people I respect and think are smart. And I’ll happily, like, take a little bit of a financial hit in the short term if I think it’ll keep going for the long term.

More helpful reading before you take the plunge

Byrne’s concept of equilibrium is powerful even if we believe that the marketplace is constantly trending towards, but never settling into that equilibrium. Efficiency is a fractal problem. It takes effort to find alpha, and it takes effort to find managers who find alpha.

At equilibrium, I contend that there is a Paradox of Provable Alpha:

If an external edge is provable, it doesn’t exist for you. either you won’t be admitted to the club or the price will negate the advantage.

The paradox casts an inescapable conclusion — you will need to rely on judgment more than track records to find managers.

The following are all outstanding reads to augment your judgment:

Letter to a friend who just made a lot of money (Graham Duncan)

This is one of the best things I’ve read on delegation. To allocate “decision space” use a qualitative formula:

credibility = proven competence + relationships + integrity


Identify what you’re good at and how you’re going to use that strength

Our founding client, the CEO of a large home builder, is fond of saying that it’s common for people to make money like professionals and then invest it like amateurs. Warren Buffett says that if you don’t know who the dumb money at the poker table is, you’re the dumb money. In order to avoid being the amateur or the dumb money, I would first try to establish what you and people who know you well believe you have a lot of credibility in doing.

Delegating “decision space”

General Stan McChrystal, who together with his chief of staff, Chris Fussell, led the U.S. military’s Joint Special Operations Command, observed that their job in running all of the special forces units in Afghanistan was to assess the various team captains’ credibility and then give them the appropriate amount of “decision space” based on that assessment. To allocate decision space they used a basic formula: credibility = proven competence plus relationships plus integrity.

I see the task of managing a pool of one family’s or foundation’s capital as essentially that same exercise — assess people’s credibility on a given activity, and then give them the appropriate amount of decision space based on that assessment.

What you need to do is assess your own credibility and that of potential partners, and then decide how to divide up the decision space over your capital. It’s important to take your own ego out of it and assess your own comparative advantage with clear eyes. Warren Buffett gave his entire savings to the Bill and Melinda Gates Foundation to manage his charitable giving; he had a quiet ego and saw that they could do it better than he could ever realistically do himself. Bill Gates owns a ton of Berkshire Hathaway because he knows that Buffett is much more credible on making investments than Gates will ever be himself.

The bottom line is that giving your team captains both autonomy and accountability is critical.

The no-man’s land, which we see people fall into all the time, is where the capital owner wants to have one foot on the playing field and one foot off, suggesting ideas to the manager of the capital without having to execute them. That puts the manager in a uniquely bad position: if they pursue the investment and it doesn’t work, they get the blame; if it does work, the owner gets the credit. Several prominent family offices have gone through way too many CIOs to count because of this dynamic; now no one credible will ever again take the job because they correctly realize that it’s a “tails you win, heads I lose” proposition.

Figure out how you’re going to build trust with your manager

Assessing credibility and building trust is a skill, and it’s learnable.

I have a question I ask candidates when I’m hiring them for a skill set I don’t have: “if you were going to hire someone to do this, what criteria would you use?” The answer is often wildly different for apparently similar people with similar backgrounds and reveals what they believe to be critical based on their experience.

When it comes to a CIO to manage your capital, I would answer that question with the following criteria:

A) Someone who can provide evidence that they have good “taste” in people; has an ability to assess other people’s credibility and give them the appropriate amount of decision space; and attracts the top talent by exuding an attitude of abundance about fees and opportunities, an implicit message of “let’s compound our capital together”

B) Someone with a “quiet” ego who is pragmatically focused on making money for you (and themselves, assuming they have incentive compensation), not on scoring style or status points or constantly proving to you how smart they are — as Taleb puts it, deep down they want to win, not win an argument

C) Someone who is conservative by nature; hates losing money with a passion but, paradoxically, can still take “good” risks; and has that unusual mix of aggression and paranoia

Believability In Practice (Cedric Chin)


The technique mostly works as a filter for actionable truths. It’s particularly handy if you want to get good at things like writing or marketing, org design or investing, hiring or sales — that is, things that you can do. It’s less useful for getting at other kinds of truth.

I started putting believability to practice around 2017, but I think I only really internalised it around 2018 or so. The concept has been remarkably useful over the past four years; I’ve used it as a way to get better advice from better-selected people, as well as to identify books that are more likely to help me acquire the skills I need. (Another way of saying this is that it allowed me to ignore advice and dismiss books, which is just as important when your goal is to get good at something in a hurry.)

I attribute much of my effectiveness to it.

I’m starting to realise, though, that some of the nuances in this technique are perhaps not obvious — I learnt this when I started sending my summary of believability to folks, who grokked the concept but then didn’t seem to apply it the way I thought they would. This essay is about some of these second-order implications when you’ve put the idea to practice for a longer period of time.

Looking for Easy Games — How Passive Investing Shapes Active Management (Mauboussin)

This paper, especially page 29, shows dispersions of return in various asset classes. This is a clue to where an active or private manager can justify their fees.

How would you trade if you knew the future but not the path?

I saw a tweet:

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

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

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

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

    🧩Excerpts from the discussion

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

Investing With Your Hands On The Wheel

Newsflash: This letter’s audience has lots of professional and retail investors. There are also lots of aspiring traders or just people who want to supplement their income with “alpha” from the markets.

So I commonly get asked for advice on trading for oneself. “I have a $250k account I’ve studied A to Z…etc”

Many of the backstories are impressive. Y’all impress me. I got a non-rigorous econ degree that only required 8 core classes. And those catered to my strength — bullshitting on blue-lined pamphlets. I limp into a stellar firm that knows how to teach trading and decision-making just as it’s hiring its largest cohort ever. I’m a product of those I was lucky to be surrounded with. If I was good at anything it was assimilation. More practical than heroic ultimately.

So when a smart, bushy-tailed go-getter asks me about prospects for succeeding as a retail trader I’m torn. Trading is a hard way to make a living even when you’re sitting in the F-16 cockpit of a prop firm. Seems like it should be impossible for retail. On the other hand, I’m not built of the best stuff so who the heck am I to piss on the grit-factories that email me.

I got one of those emails on Monday. Sharing my responses(italics) here:

A few thoughts:

1. This thread from Lily is spot on

2. Listen to this interview with Darrin

Reader: What would your advice be to someone who loves markets and trading more than anything and doesn’t look at this as a chore, but rather a passion? Is it still a fool’s errand to not just DCA into QQQ and SPY and go find another interest?

Me:  99% of people should probably look elsewhere but that’s true of anything that is exceptionally hard. There still will always be the 1% who do not take no for an answer. Nobody can tell you who you are. You ultimately seize who you are. If you fall to the level of your weakest strength, you can still decide if that’s your resolve or something else.  

Reader: I know about all of the time in the market > timing the market, the Buffet bet, all of it – but maybe I am just irrationally stubborn?

Me: If you listened to the Will England interview you can hear him say that a lot of the neutrality guardrails are in place because nobody trusts anyone’s ability to time. Vol traders can’t even time vol and I’m talking about the best vol traders in the world. If this is what you think the edge is nobody is going to buy it. You will need to prove it with your own $. That said, timing is not really the edge most try to have. This interview might be helpful to expand your thoughts on it.

Reader: I guess I have seen some of my mentors trade very, very well, but maybe I am just not able to allocate as much time and attention via a full life elsewhere. Are there any resources you would recommend to explore further ideas? There are people way, way smarter than me that just say DCA into low cost interest ETFs and go take a walk, but is there anything worth anybody’s time when it comes to more active stuff?

Me: I didn’t up in this biz on my own like say Darrin did. I don’t know how those people do it, I can just listen to their stories. I’m pretty much in the camp of “get a job where you can do this full-time if you really want to”. If you can’t do this but still want to explore strategies, then fence out some capital to play/learn/experiment. For the rest of your assets stick with some kind of permanent portfolio implementation depending on your risk tolerance. You can follow folks like Corey Hoffstein, NomadicSamuel, Jason Buck, Lily for that stuff. InvestResolve guys too. All these tweet about it too and it’s all quite solid. I recommend this series by the InvestResolve team.

In general, my advice, which sounds hard but is probably easier than trying to trade for a living: get a high-paying job. 

All this focus on trying to make your money work for you is totally secondary to the biggest muscle movement — make more money with your skills or with a business. I came to the internet around 2015 to learn about investing because I already had a lot of savings, a house etc. So I was like “now what to do with the money”. Most of my option traders friends have no process or framework for investing. In fact, most of them find it to be a waste of time to give it a lot of thought. I don’t fully agree with them on that, but I was like that myself. Instead, we all focused on — “I want to make so much money that it doesn’t matter if I just stuck it in t-bills”. It’s a pretty jarring answer compared to conventional thinking and it’s not fully right — but there’s truth in the instinct.  When I look at people who have built more wealth in the past decade from investments than income I think — “that looks fragile”.

Everyone wants to feel like they slayed the investing dragon and were great at making their money work for them. Meanwhile, there’s a bunch of folks out there who want to focus on what they’re good at, have hobbies and be f’n happy on the weekends not researching the next investment or managing rental properties. They out there just thinking — I’m gonna go get paid seven figures a year on a W2 working for an elite organization.

I added this later in a tweet and it’s just straight talk if someone is sweating lots of financial success:

Be special enough to get pedigree


Be special enough to not need pedigree

In other words, this reduces quite easily to things that are very hard. Invoking the “Why would it be otherwise” line.

And as far as being methodical about the original question of trying to earn a return on $250k, John has said it well:

One of my favorite writers,

just published an incisive climate posture post [paywalled]. It has this amazing passage that can be ported from climate contexts to people’s need to trade (bold is mine):

The narrative web of the climate discourse is very hard to map, but one thing is clear: Almost everybody is an NPC in the current situation, and is primarily desperately solving for how not to feel like an NPC. This is an important point. Humans have a strong tendency to confuse a psychologically satisfying amount of agency with a materially effective amount. A broad culture of what we very-online people call cope rules everything around us when it comes to climate. It is a deep-rooted tendency, and an understandable one. Much as we might intellectually desire such laudable goals as the survival of almost everybody through a planetary crisis, our sense of meaningful existence is tied to individual agency. We’d rather stride grim-faced with a gun across a devastated post-apocalyptic landscape, masters of our own fates, than feel helpless within a world that’s largely doing fine and even providing for us.

What. A. Line:

Humans have a strong tendency to confuse a psychologically satisfying amount of agency with a materially effective amount.

Don’t just stand there, do something, right?

But also…

A trader pinged me saying:

There is a false dichotomy between 100% passive and 100% active. I feel like with the right mindset/education/strategies, there are ways to meaningfully add value to one’s portfolio via lower touch strategies and this can be done in addition to one’s day job.

Like in the guys email, one of his first questions was whether it is a fool‘s errand to not just DCA into SPY. I feel like the investment education landscape is so distorted that DCA SPY is the baseline. I would almost argue it should be quite easy to outperform buy and hold, especially on a risk adjusted basis without having to spend hours of screen time.

Ultimately, questions like this are ones without tidy answers.

This is where I shake out on it for now:

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

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

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

This is related in a weird way but one of my favorite interviews was with Professor C. Thi Nguyen, author of Games: Agency As Art. It’s a penetrating twist of how art or creation is a form of agency — games allow players to take on different agency roles. To step outside themselves in a low-stakes way.

The pragmatic view of investing/trading is and should be for profit. But whether partitioning some of that mental and monetary budget to satisfy agency needs might say something about whether you are getting enough of that in other endeavors. Investment as agency?

I’ve been reading Ed Thorp’s autobiography with my 10-year-old (very slowly I might add — between myself and the boys we are simultaneously reading 5 books. Sympathies to Yinh who is surrounded by broken brains). We are about to start the second half of the book where Thorp leaves gambling (after the casinos tried to kill him by jamming his car’s accelerator!) and sets his sights on the world’s greatest casino — Wall Street. But despite being on the Mount Rushmore of investors, Ed left the game content to invest his fortune with other managers, seeing more to life than the day-to-day of this particular game.

An interesting side-note was Ed and Claude Shannon were good friends and accomplices in devising the world’s first wearable computer (which they used to break roulette). Claude was also a wildly successful investor. Both of these men saw investing as an interesting puzzle. Money was a byproduct. They didn’t seem to care too much about money other than its evidence of their hypothesis.

There’s a line in Tomorrow, and Tomorrow, and Tomorrow where celebrated video game designer describes a (less than mentally healthy) scene from his youth:

They were in her car on the way back from a math competition in San Diego, and Sam was giddy with the feeling of being better than everyone else at something that he didn’t care about at all.

I have several option trader friends who are misfits — amongst the smartest traders out there getting paid big bucks at the firms you know. They could care less about investing but find trading fun. This is just a game that pays way too much for what it requires of them. They have all these other nutty interests and would sooner off themselves than read an investing book. Me, I’m just a normie pragmatist. I did it for the money, not because I love the game. In fact, one of these friends has told me he thinks I’m totally f’n weird because I don’t love the trading part, I love the conceptual parts, the building parts — which is the exact opposite of his position.

My ability to pull any useful insight from this is strained. But it’s probably just some cliche — think deeply about what you’re good at and what you want…and the conversation that’s hardest to have with yourself — why do you want it? The answers are always laden with some amount of insecurity, but I think that’s what keeps us alive. And abolishing insecurity probably isn’t a reasonable or even respectable goal. Coming to agreeable terms with it strikes me as more human.

It must be nice to find that thing that’s in-demand that comes really easy to you. I wonder what an emphasis on finding that would look like rather than preaching the grit catechism.

The Pods On Top Of The Food Chain

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

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

Which serves the analogy perfectly.

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

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

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

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

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

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

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

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

A few thoughts of my own

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

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

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

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

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

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

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

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

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

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

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

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

Sorry, back to the body.

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

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

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

Learn more:


This is a long but good thread by @FundamentEdge

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

🎙️Big Shorts and Big Longs (Capital Allocators)

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

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

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

Byrne Hobart’s primer from his evergreen Capital Gains Substack

Outline of the Risk-Neutral Probability lessons

I published a new lesson. It’s a big post with 5 embdedded sub-posts and exercises for the reader. It ties together many concepts I write about.

I adapted the Tweet thread I used to promote it into this post to provide an outline for prospective reads.

Understanding Risk-Neutral Probability (Moontower)


To let you build your own understanding, the lesson begins with a progression of simple questions.


From this simple progression, you have actually self-derived a foundation for a key concept that we are going to get some mileage out of. Plus more practice to help you internalize the concept. It will make sense!


For those learning about derivatives or even pros who aren’t academically minded (myself included) there are exploration detours into 2 topics.

Useful Detours

1. Advanced Topic: How To Compute Risk-Neutral Probabilities From A Binomial Tree (Moontower)

That section includes exercises, again so you can own the knowledge, and then a derivation that you will probably have figured out intuitively:

  1. Advanced Topic: ReplicationReal World vs Risk-Neutral Worlds (Moontower)

    This one will be especially fun for traders because it includes:

    💡 What seasoned option traders get wrong

    💡 How divergence between real and risk neutral probability lead to mutual opportunity for speculators & traders

    I give examples from:

    1. Warren Buffet
    2. 2. FX Carry

Returning to the main post

After the detours, we pick up again with the idea of risk-neutrality and make a logical step into the principle of that underpins how investments will be priced:

🧽risk absorbability


This is an underappreciated idea. I can tell because people confess their ignorance all the time when talking about their great investments. They don’t understand that the default assumption should be idiosyncratic risks don’t pay.

Why not?

Consider 2 significant ways that an investing entity can absorb risk and we use simple examples to demonstrate how risky propositions can be rationally priced with no risk premium:

1. Bet Sizing

2. Diversification

Let’s look at each:

Risk absorption by bet sizing


Risk absorption by diversification:


The key takeaway: The more risk you can absorb, the closer your bid approaches the risk-neutral (ie arbitrage-free) price.

Bring it altogether

Now we get to tie all of this together to reason about investing broadly. There’s a short recap before we get to heavier lifting.


Now we’re ready for the real discussion which starts with an an obvious question:

🏗️Why did we slowly build all this theoretical scaffolding?

2 reasons that I categorize as:

1. Instrumental

2. Appreciative

These are essays in themselves.

🔗Instrumental Reasons (aka the practical reasons to learn this stuff)

We divide the audience for this into

a) Traders

b) Investors


I also give an example of the line being blurry between them:


Then we really address the implications for investors which applies to many more people.

We do this in Socratic form.


⚕️Then I offer some prescriptions


That covers instrumental reasons but I am an advocate of financial masturbation. So we also look at the appreciative reasons to understand this stuff.

Like I mentioned, this is an essay unto itself:

🔗Appreciative Reasons

This is the outline:


Followed by some cope:


Then closing comments and links for further reading. This post tied together a lot of material.


🔗Links For Further Reading

Reflections On Getting Filled

I had a little financial adventure this week that’ll I’ll try to connect to some broader concepts in the Masochism section.

My wife’s sister’s family lives next door. We removed part of the fence so we have our own little commune with 3 generations living together. It has been the largest life upgrade I can think of.

The catch: it’s temporary — both families are renting.

We aren’t actively looking for a house to buy, but we asked our friend whose also the realtor who sold our house for us to just keep an eye out for “situations that could accommodate both our families”.

We got a call this week. She has a client selling a house that hasn’t been on the market for 50 years. An old 3/2 near the elementary school on half an acre. Oh yeah, and they are also selling the completely undeveloped flat half-acre lot behind them (there’s an easement making this back parcel a “flag lot”).

By offering the lots separately they are able to draw a wider buyer pool. But also makes the deal hairy. If you just want the front lot, you will be reserved in your bidding because you know at some point there’s going to be a house built in your backyard. Who wants to live next right next to a construction project for 2 years?

But this is also tricky for the person who buys just the vacant parcel. The 3 adjacent neighbors and the family who buys the lot with the house are going to NIMBY the permit and building process. Not to mention, that you need to pull utilities to the vacant lot (estimated to be about $150k).

The ideal buyer would want to lift both lots presumably with a plan to live in the old house while they build a new house. But that is a tiny buyer pool — population us.

We bid on both as a package. Because of the complications described earlier, the parcels aren’t selling immediately. We made a cash bid below the sum of where the legs are bid with the sense that the sellers know if they fill a single leg, it will be harder to fill the other and we were the clean option.

We would find out the next day if our bid was accepted.

I’ll bring you into the discussion of risk we had that night as we waited.

We believe our bid had a margin of safety of about 25% below fair value based on comps (comps for the vacant lot are higher variance and indirect — basically backing out land value from the price of teardowns and near teardowns). Building is a hairy proposition around here so even though you shouldn’t expect a builder’s margin, there is some margin which I describe as the market’s “Here’s a carrot, I dare you to upend your life to navigate the labyrinth of CA construction”.

We didn’t expect to get win the bid. Even though the bids for the individual lots were shakier because of the total dynamic, we were still bidding well below them. But what if we did?

I’d actually be concerned. Since the fair value of the lot with the house was easily-comped, getting hit would tell me the vacant lot had a landmine if it isn’t purchased by say, a direct neighbor (where we assume the individual lot bids came from). What if the direct neighbor was bidding for the lot because they just wanted more space (or a pool/tennis court, etc)? If we got hit perhaps it’s because the utilities are way more expensive to pull (I have a friend that owns a bunch of SFH’s in town and told me a story of how the water utility wanted $750k to feed a hillside parcel).

In short, if you bid below the sum of the legs and you get filled, you need to update your prior of what fair value is. We had a few knowledgeable friends including a local builder lined up to walk the property with us in the event that we get our bid hit. I was planning to be down at the permit office learning what I could this coming week, ready to ask the utilities about “worst case scenario quotes”, and primed to talk to insurance companies (Allstate and State Farm who make up the bulk of CA property insurers have stopped underwriting new policies in the state as of this summer— this is a whole other topic that gives me black swan vibes — well grey swan if I can see it guess). In short, we fired out a bid knowing we could back out risklessly. If we got filled it would be a highly restrained win until we investigated the risks more closely.

As expected our offer bid was not accepted.

Money Angle For Masochists

The meta-risks above exist wherever deals are made.

Adverse selection

There is a lot of money floating around the Bay Area, a shortage of supply, and multi-generational relationships that we are not insiders of(we’ve been here close to a decade only). Given our relationship with the broker and the hair on this deal, we felt some of that was mitigated but probably not all. After all, our limited knowledge of the neighbors is a soft underbelly in our reasoning.

The catchy name for this concept is the “market for lemons”. Its strongest form contends that all used cars are overpriced according to the logic here. As a matter of practice, I suggest using that heuristic as the default but seek to disprove it because there is always the possibility of an inefficiency in your specific situation. It would be worthwhile to consider what conditions would make your situation more or less likely to lend itself to adverse selection.

Whenever you compete for a deal you must understand where you stand in the pecking order, who else has seen the deal, and what their passing on it might be saying.

Winner’s Curse

Fair value is not what you think conditional on getting filled. In Ben Orlin’s book Math Games With Bad Drawingshe discusses the value of playing auction games:

Because everything has a price, and auction winners often overshoot it.

We live in a world on auction. Photographs have been auctioned for $5 million, watches for $25 million, cars for $50 million, and (thanks to the advent of non-fungible tokens) jpegs for $69 million. Google auctions off ads on search terms, the US government auctions off bands of the electromagnetic spectrum, and in 2017, a painting of Jesus crossing his fingers fetched $450 million at auction. Before we dub this the worst-ever use of half a billion dollars, remember two things: (1) The human race spent $528 million on tickets to The Boss Baby, and (2) it’s a notorious truth about auctions that the winner often overpays.

Why does this winner’s curse exist? After all, under the right conditions, we’re pretty sharp at estimation. Case in point: In the early history of statistics, 787 people at a county fair attempted to guess the weight of an ox. These were not oxen experts. They were not master weight guessers. They were ordinary, fair going folks. Yet somehow their average guess (1,207 pounds) came within 1% of the truth (1,198 pounds). Impressive stuff. Did you catch the key word, though? Average. Individual guesses landed all over the map, some wildly high, some absurdly low. It took aggregating the data into a single numerical average to reveal the wisdom of the crowd.

Now, when you bid at an auction — specifically, on an item desired for its exchange value not for sentimental or personal reasons — you are in effect estimating its value. So is every other bidder. Thus, the true value ought to fall pretty close to the average bid. Here’s the thing: Average bids don’t win. Items go to the highest bidder, at a price of $1 more than whatever the second highest bidder was willing to pay. The second-highest bidder probably overbid, just as the second-highest guesser probably overestimated the ox’s weight.

To be sure, not all winners are cursed. In many cases, your bid isn’t an estimate of an unknown value but a declaration of the item’s personal value to you. In that light, the winner is simply the one who values the item most highly. No curse there.

But other occasions come much closer to Caveat Emptor: The item has a single true value which no one knows precisely and everyone is trying to estimate.

I like an example from Recipe For Overpaying: investor Chris Schindler explains why high volatility assets exhibit lower forward returns: a large dispersion of opinion leads to overpaying. He points to private markets where you cannot short a company. The most optimistic opinion of a company’s prospects will set the price.

Getting filled in an auction should make you update fair value. In Laws of Trading, Agustin Lebron gives an example from the market-making context. He starts by echoing what we know about the winner’s curse — any bidding strategy requires the bidder to estimate the item’s fair value conditional on having won the auction. This requires estimating how many bidders and how wide their uncertainty is regarding the item. But the problem is that some bidders are better informed than others. So if you are relatively uninformed and win the auction you are sad. [This topic came to life constantly to anyone who came to the StockSlam sessions — Steiner generously joked that if you traded with the Kris bot, you track down the info that shows how you just got arbed.]

But Agustin then gives an example of how to Bayesian update:

You may interpret a market maker’s width as an expression of confidence and using that to update your fair value by weighting their mid-price by the confidence.

If I’m 54.10-54.30 and you are 53.50-53.90 then I’m 2x as confident. So my new fair value is 2/3 x 54.2 +1/3 x 53.70 = 54.03

My Bayesian analysis of being filled on a limit order vs market order

Imagine a 1 penny-wide bid/ask.

If you bid for a stock with a limit order your minimum loss is 1/2 the bid-ask spread. Frequently you have just lost half a cent as you only get filled when fair value ticks down by a penny (assuming the market maker needs 1/2 cent edge to trade). But if you are bidding, and super bearish news hits the tape (or god forbid your posting limit orders just before the FOMC or DOE announce economic or oil inventory), your buy might be bad by a dollar before you can read the headline.

If you lift an offer with an aggressive limit (don’t use market order which a computer translates at “fill me at any price” which is something no human has ever meant), then your maximum and most likely loss scenario is 1/2 the bid-ask spread.

Do you see the logical asymmetry conditional on being filled?

Know what you’re leaning on

When you are a market-maker and you get filled it’s because your bids and offers are conditional on other bids and offers in the market. My bid in XLE might be pegged to the market’s bid for OIH. This is known as “leaning on an order”. My model has some value for the spread and if I get filled, I’m presumably able to leg the spread at a price I’m happy with. If I didn’t think I could leg the spread, I’d adjust my bid for XLE.

In real life, I might bid for a house but there’s still some conditional peg in place. If the stock market suddenly dove on a surprise 75 bps rate hike, I’d pull my house bid. It’s stale. The world and my assessment of the house’s value has changed. The period that defines staleness differs depending on whether you deal in real estate or HFT but the concept persists.

[This actually happened to us when we were in contract to sell our TX property last year. I had to act pissed when the realtor said the buyer’s financial advisor suggested they pull the bid when the stock market nosedived in the spring, but secretly, I thought “good advisor”. He was very right. We ended up selling the house nearly 10% cheaper].

The key is to always keep the reasoning for the price you bid or offered fresh. If you lose sight of why the price you are bidding makes sense, then your decision is no longer linked to an auditable chain of logic where you can go out and test the assumption (ie for example if you tried selling some OIH you might find the bid isn’t real or unusually thin and therefore your XLE bid might be “propping up the market” and the OIH bid is just leaning on you — it just has a different assessment of the spread value between the 2 stocks). Once you lose the chain of logic, you’ve lost the grip on the kite. Your bids will just float capriciously in the winds of emotion, narrative, and behavioral biases.

Sports Analytics Books

My biz partner friend is way more of a math guy than me. If you want to be a trader you’ll get more mileage studying gambling than investing. Although I’ve done some study of gambling, it’s nothing compared to my friend’s info diet. He’s been a giant sports analytics nerd for the past 20 years (one day I might share a story of his meeting with an NFL team owner. I get stressed thinking about it, so can’t imagine how my buddy feels).

I asked him for some book recs in the vein of Scorecasting written by AQR quant Tobias Moskowitz (you may remember me recommending his children’s novel Rookie Bookie).

The list:

  • Baseball Between the Numbers: Why Everything You Know About the Game Is Wrong
  • The Book: Playing the Percentages in Baseball
  • Seminal: Bill James
  • Win Shares
  • Basketball on Paper: Rules and Tools for Performance Analysis
  • The Expected Goals Philosophy: A Game-Changing Way of Analysing Football
  • The Hidden Game of Football: A Revolutionary Approach to the Game and Its Statistics

Finally, my internet friend Andrew is an independent trader who came out of the sports gambling world. I’ve spoken to him several times. Very smart, you should follow him and check out the sports modeling books he’s written:

Weird Baby

Some recent convos had sex with lingering thoughts from a podcast on a bed of a blank page this morning and today’s Moontower is the weird baby that popped out.

I recently listened to my first episode of Dan Carlin’s Hardcore History — a tour of the transatlantic slave trade entitled: Human Resources. Dan’s story-telling and research shine in this nearly 6-hour episode. He deserves all the accolades he gets. The style, quality and nuance of his work are well-advertised, I’m just late to the party. He immediately jumped into my ring of favorite creators.

I’m also a fan of the Founder’s podcast. Because I found an interview with its host David Senra to be as compelling if not more than the books he highlights (a high bar), I decided to hunt down interviews with Carlin. The first one I clicked on with Lex Friedman did not disappoint.

Here are 4 excerpts that stood out to me, but the whole interview is good.

I’ll post one of the excerpts here because I like Carlin’s approach — he answers the question probabilistically (and his gambling mindset in general to handicapping answers is prevalent in the way he reasons) but explains the framework he is adopting to approach the question.

[Meta observation: Answers to questions often fall out trivially from the model you choose to approach it, so it’s a reminder that your choice of model in the first place is critical — any ensuing logic will unconsciously inherit its assumptions. The work of overriding assumptions to adjust for differences between the reference model and the question at hand is where devilish details lie. But when encountering an argument, it’s a good idea to question the choice of model before quibbling over details.]

On to the excerpt:

Lex asks how we will “destroy ourselves”. Carlin gives a framework for handicapping what calamity will undo us.

Lex: If you were to wager on the method in which human civilization collapses, rendering the result unrecognizable as progress, what would be your prediction? Nuclear weapons? A societal breakdown through traditional war? Engineered pandemics, nanotechnology, artificial intelligence, or something we haven’t anticipated? Do you perceive a way humans might self-destruct or might we endure indefinitely?

Dan’s response (emphasis mine):

My perspective is primarily influenced by our ability to unite and focus collectively. This informs my estimates of the likelihood of one outcome versus another.

Consider the ’62 Cuban missile crisis. We faced the potential of nuclear war head-on. That, in my view, is a hopeful moment. It was one of the few instances in our history where nuclear war seemed almost certain. Now, I’m no ardent Kennedy admirer, despite growing up during a time when he was almost revered, especially among Democrats. However, I believe John F. Kennedy, acting alone, likely made decisions that spared the lives of over a hundred million people, countering those around him who preferred the path leading to disaster.

Reviewing that now, a betting person would have predicted otherwise. This rarity underpins our discussions about the world’s end. The power to prevent catastrophe was in the hands of a single individual, rather than a collective.

I trust people at an individual level, but when we unite, we often resemble a herd, degrading to the lowest common denominator. This situation allowed the high ethical principles of one human to dictate the course of events.

When we must act collectively, I become more pessimistic. Consider our treatment of the planet. Our discussions predominantly center around climate change, which I believe is too narrow a focus. I become frustrated when we debate whether it’s occurring and if humans are responsible. Just consider the trash. Disregard climate for a moment; we’re harming the planet simply through neglect. Making the necessary changes to rectify this would necessitate collective sacrifice, requiring a significant consensus. If we need around eighty-five percent agreement worldwide, the task becomes daunting. It’s no longer about one person like John F. Kennedy making a single decisive move. Therefore, from a betting perspective, this seems the most likely scenario for our downfall as it demands a massive collective action.

Current systems may not even be in place to manage this. We would need the cooperation of intergovernmental bodies, now largely discredited, and the national interests of individual countries would need to be overridden. The myriad elements that need to align in a short span of time, where we don’t have centuries to devise solutions, make this scenario the most probable simply because the measures we would need to undertake to avoid it appear the least likely.”

[a later thread that rounds out his thinking on this]

“Returning to our primitive instincts, we are conditioned to address immediate and overwhelming threats. I hold a considerable amount of faith in humanity’s response to imminent danger. If we were facing a cataclysmic event such as a planet-threatening explosion, I believe humanity could muster the necessary strength, empower the right individuals, and make the required sacrifices. However, it’s environmental pollution and climate change that pose a different challenge.

What makes these threats particularly insidious is their slow development. They defy our innate fight or flight mechanisms and contradict our ability to confront immediate dangers. Addressing these problems requires a level of foresight. While some individuals can handle this, the majority are more concerned, understandably so, about immediate threats rather than those looming for the next generation.

Could we engage in a nuclear war? Absolutely. However, there’s sufficient inertia against this due to people’s instinctive understanding. If I, as India, decide to launch an attack against China, it’s clear that we will have 50 million casualties tomorrow. If we suggest that the entire planet’s population could be extinguished in three generations if we don’t act now, the evolutionary trajectory of our species might hinder our response.”

The remaining excerpts cover:

  • An example of how propaganda can scramble your beliefs in a way that creates collective distortions that are hard to see
  • The problem with dictators or strongmen even if they are wise and benevolent
  • Will the US tear itself apart in a second civil war?

[Note: I used GPT-4 to clean up sections of this transcript:]

Money Angle

Here’s a stream of consciousness reflecting on a few recent private convos jambalayed with some of Dan Carlin’s thoughts.

I was hanging out with a good buddy (and former biz partner) and talking shop a bit about the options biz. I’ve heard about how implied correlation is “trading in the 0th percentile” but that selling it continues to be profitable in 2023 because it’s “realizing” even less than implied (to be clear he runs a big strategy and we don’t discuss what he does so there is no suggestion that he is also doing this. He merely confirmed that implied corr was historically low). This reminded me of the misery that was 2017, where the best trade would have been to just lay into single-digit SPX vol because realized vol was so low you’d wonder if the stock market even opened anymore. The opening bell rings and you immediately ask “What’s for lunch?”.

While we were walking around Ghirardelli Square, my boy made a throwaway comment that my mind hasn’t emptied from the trash.

The hard leg is always where the money is.

I thought about how, in 2021, the dumbest possible idea — buying a dog coin — was the best trade at one point and shorting it was too at a different point. But both were hard at the ripest times to do it and easiest when they were riskiest.

I thought about the double lot property I looked at this week with a realtor friend (the same one who sold both my house and my biz partner’s — if you are in the East Bay I’d be happy to intro. Good realtors are like good mechanics — gold amongst pyrite). There’s no math that makes the price of the homes make sense. Property in a specific location has little substitute and just trades like art. As my realtor properly diagnoses — “Kris, you’re like my lawyer father, you see the risk. But the people who win these auctions only see their family on a Christmas card”. This was not a knock on those people. As my friend Jared likes to say, their bank accounts have a phone number in them — I’ve seen enough behavior here to know that while folks aren’t Miami-flashy, a Ferrari is a rounding error sum of money in a home negotiation, not a decision. If you move from the Bay Area or NYC your bid would be obnoxious to the locals too.

It feels to me that everything is a momentum trade — selling dispersion at low levels, buying homes at 0 after-expense cap rates, having no top on what you’d pay for Harvard, hell, it’s an imperfect measure but even stock market earnings yield is less than t-bills.

It’s all momentum until some grand event makes it abundantly clear that the world has changed. Then you get the situation currently embodied in the no-bid CRE markets of say SF and Chicago.

Liquidity is utterly discontinuous in such a world. Value will become increasingly resistant to traditional measurement because there is so much wealth in search of a return you can reason that any opportunity where the math makes in a textbook spreadsheet, the value is sitting on a landmine, already passed on by the infinitely patient family offices of moguls who are not forced to chase LP-friendly payoff diagrams.

I chatted this week with another good friend who finds and stacks strategies at a well-known pod shop. He talked about a trend he had seen in motion much earlier — the accelerating difficulty in finding talent/alpha. He’s impressed at the speed at which the market for alpha is getting efficient but this is what you’d expect when pods are eating the investment world. Millenium manages $50B that is laser-focused on uncorrelated skill (grapevine tells me they increased how many pods that trade dispersion in recent years — cue the “markets are biology not physics” analogy — which means the marginal bid for single stock vol has increased. This actually means the environment for covered call selling might be unusually nice. This doesn’t contradict my broad admonitions about call-selling. It actually makes my point — that you should be discerning about the practice and not think of it as passive income or free money but understand what circumstances make the strategy more or less ripe.)

All of this makes me wonder about the distribution of investment outcomes in aggregate. Suppose the underlying economy is steady. Does the median return increase at the expense of the left tail (keeping the expectancy the same)? In a world where capital is more easily deployed and more concentrated, what happens to the shape of returns?

Look at the deal the Saudis have offered Mbappé or their pot-splashing with LIV golf. It all feels related. Financialization, private-equityization, Softbankization. Increasing rewards for capturing attention (see athletes or Cathie Wood). The internalization of rage bait as a social media strategy. Twitter X is rapidly being consumed by engagement tactics (dystopian thought: this trains people to be numb as they will eventually adopt defenses against engagement until we lose the ability to know what we should pay attention to). The harder profit is to find the greater the temptation to cut another forest down. We are great at identifying growth. Less great at understanding its costs. Wouldn’t be a bad tagline for America if taglines were honest.

(In Dan Carlin’s slavery pod I felt that the moral concerns didn’t gain steam until the cost of enslaving Africans became more apparent. You know that expression “narrative follows price”? Maybe we don’t moralize until a loathsome but profitable practice reaches its blood-from-a-stone phase and the cost of moralizing is lower. If you try on that perceptive for a day you’ll either want to claw your eyes out or you’ve already sold humanity to zero.]

All of this echoes Dan Carlin’s suspicion that our undoing will be collective action problems. If you believe that the logic of efficient markets (a collective action coordination mechanism that differs from democracy) is playing itself out in a rules landscape that has significant divergences from the political question of “what is good for broad-based flourishing”? You could imagine capitalism resting on many different types of rule frameworks. But you’d also expect the ruling framework, the one called a “free market”, to be shaped by its victors (corporations are people too, right?).

To Carlin again — propaganda can scramble your beliefs in a way that creates collective distortions that are hard to see

[Carlin is a war historian and while he admits to his bias towards individualistic ideals “I’m famously one of those people who buys into the ideas of traditional Americanism”, his characteristic nuance is well-displayed in his deep skepticism of the “military-industrial complex” and how its inclination towards self-preservation as an institution often exerts undue influence in when America looks at its menu of choices]

“Many people living today seem to think that patriotism requires a belief in a strong military and all the features we have in the present. However, this is a departure from traditional Americanism, which viewed such elements with suspicion during the first hundred years of the republic. They saw them as foes to the very values that Americans celebrated. The question arises, how could freedom, liberty, and individualistic expression thrive with an overarching military always engaged in warfare?

The founders of this country examined examples such as Europe and concluded that standing militaries or armies were the enemy of liberty. Today, we have a standing army deeply woven into our society. If one could go back in time and converse with John Quincy Adams, an early president of the United States, and reveal our current situation, he would likely find it terrible and dreadful.

Somewhere in our history, Americans seemed to have strayed from their path and forgotten their founding principles. We have successfully combined the modern military-industrial complex with the traditional benefits of the American system and ideology, so much so that they have become entangled in our thought process. Just one hundred and fifty years ago, they were seen as polar opposites and a threat to each other. When discussions arise about the love of the nation, I harbor suspicion towards such sentiments.

I am wary of government and strive hard not to fall prey to manipulation. I perceive a substantial part of what they do as manipulation and propaganda. Therefore, I believe a healthy skepticism of the nation-state aligns perfectly with traditional Americanism.”

I’ll leave you with a thought — let’s do an analogy substitution.

What if the version of capitalism we endure today is the military-industrial complex and Georgism is actually more aligned with the meritocratic principles this country is supposedly based on?

Anxious You’re Short A Self-Reliance Put?

I was running a few car errands yesterday thinking and my mind wandered onto a particular anxiety — why inflation is so psychologically upsetting.

[If you’re a well-adjusted person you don’t have such thoughts pop in your head while you’re pulling into Ace Hardware so count yourself among the lucky. But part of opening this email is you get some of my brainworms. Turns out nothing is free, including free newsletters.]

Inflation is obviously distressing because nobody wants to run faster to stay in the same place which is what you must do if your costs outpace your income. But inflation, especially sit-on-our-ass symbol manipulators like myself (and probably many of you reading a Substack on your work computer), awakens a fear that otherwise just harmlessly beeps in my subliminal background processes — the recognition that my pleasant, modern life is built on abstraction.

And there’s one abstraction in particular that I want to rub the invisible ink decoder on to expose — the economic principle of specialization. Modernity has so fully internalized this principle that we take for granted that the crops will grow and trees will be dragged from the forests for milling. This assumption allows us to focus on whatever our own crafts are knowing that we can convert the products of those efforts into money which we can exchange for food.

Inflation is a giant monkeywrench in the exchange rate between our craft and all the others we rely on to make it through breakfast without major surprises. The invisible solutions become revealed for what they are — assumptions.

I’m not sounding any alarms — specialization and its logical cousin comparative advantage are formidable foundations for flourishing and prosperity. I’m only pointing out how inflation causes you to notice the assumptions and that feels like someone asking me “do you know what’s in that?” as I bite into a hot dog.

In Pathless Path, Paul Millerd writes:

In the 1970s, academic turned farmer Wendell Berry wrote about how economic success includes the hidden cost of depriving people “of any independent access to the staples of life: clothing, shelter, food, even water.” What was once the riches of self‑reliance have become things with a price.

Tim Wu made this point in a widely read essay titled “The Tyranny of Convenience,” where he argues that convenience, “with its promise of smooth, effortless efficiency…threatens to erase the sort of struggles and challenges that help give meaning to life.” Wu argues that many see convenience as a form of liberation. People aim for “financial independence” only to realize when they achieve it that they’re only independent in the narrow sense of being able to pay for everything.

I have anxiety about my distance from self-reliance. I’m not handy, I have a black thumb, and I tolerate prepping food (I can’t call what I do “cooking”). I have a profound sense that if we were born in another era or place my life would be somewhere between “less pleasant” and “brutal”.

I often think about this interview response by hedge fund manager and one of the greatest Magic The Gathering players of all time, Jon Finkel:

I think I’m a bright guy, but I’m also aware of how much of my success has been luck. I was born a white man to upper middle class parents in the wealthiest country the world has ever known. I had a very specific set of skills that are easily translatable into money in our current society, but would have been far less useful for most of human history. The game I got obsessed with happened to grow and expand into the enormous thing magic has become, and it just so happens that I was actually good at it. So basically, I don’t think I have an edge in everything at all. I think I had a couple specific intellectual skills and it just so happens that they’re most obvious in the games that all the smart people I know also play, so it makes me look more talented than I really am.

We are short a far out-of-the-money put struck at self-reliance that’s denominated in fiat currency. The premium of that put start showing up on the End of Day Risk Report when inflation rates accelerate.

With all this said, I also hold tremendous sympathy for those who might be self-reliant but haven’t proportionally benefitted from financialization (the symbol manipulation industries of tech and finance are the lions closest to that carcass). They might be long the teeny-delta return-to-primitive put, but they are also short a straddle near the meat of the distribution. Moderate upticks in inflation that outpace income, create a similar anxiety — it erodes the stored value of their prior work known as savings. But they might have the extra disadvantage of being under-educated in the abstractions of money and investing. Symbol manipulators will have more confidence in their ability to mitigate inflation by investing in value-producing ventures.

[Note that “value-producing” is irrespective of currency — if you care for children, no matter what happens to the world, there’s going to be an exhange rate for what the work is worth relative to something else of tangible value. Nannies make 40 bananas an hour regardless of what the inflation rate of USD says].

A few nights ago I was chatting with my mom.

My mom is a smart lady. She taught me how mortgages worked when I was in elementary school. I was fortunate to be born to someone who taught me about money, savings, interest and loans.

But she doesn’t understand investing.

She didn’t understand dividends until Sunday. She didn’t understand the source of return for a business or the idea that a business owner is a “capital allocator” and how they must choose what to do with their profits from a menu that includes:

  • giving money back to investors which can be done through:
    • dividends
    • buybacks
  • re-investment back into the business
  • mergers and acquisitions

What they choose to do is a revealing action. It signals what they may think of the company’s health or foreseeable prospects.

So even if I have the standard anxiety about inflation plus some personal insecurity issues that it stirs about self-reliance, they are low-grade neuroticism around extremely remote events like hyperinflation.

I feel for the average American who I’d bet is even less informed than my mom.

[I shared this thought with the local social club I’m in and there was plenty of interest in basic personal finance talks, so I’m collaborating with a few members to do some firesides at the club.]

Look, I understand the arguments for moving from defined benefit (ie pensions) to defined contribution (ie 401k) plans but “democratizing investment choice” without the proper scaffolding feels like an invitation to have the wolves educate the sheep.

I’m capable and enjoy helping people think better about this stuff so I’ll keep on. But just a reminder, that if you feel comfortable with investing basics (and most of this readership does!) don’t take it for granted that your neighbors do too. A nice way to give back locally or just in your family might be to organize a session where no question is too basic. Create a no-judgement zone. You, right now, are sitting there with the skills to alleviate some of your friends and family’s anxiety.

In return, I’m sure they’d love to help you navigate an Ace Hardware.