Moontower #183

Friends,

Wednesday’s Moontower Munchies, Mondegreen Minds, was a celebration of computational thinking. I shared a quote by Montessori instructor Matt Bateman in reference to math:

It matters for your soul. Math is the realm of precision, exactitude, quantity, measurement, and logic. If that’s the realm you’ve populated with secondhand incantations, that will invariably transfer to areas of life in which those things are cognate. (Which is every area.) The exactitude of the mind, the quality of judgment of the mind, and the independence of the mind are interrelated.

He quotes Maria Montessori herself:

When you say “There goes a man of vague mentality. He is clever but indefinite,” you’re hinting at a mind with plenty of ideas, but lacking in the clarity which comes from order period of another you might say, “He has a mind like a map. His judgments will be sound” in our work, therefore, we have given a name to this part of the mind, which is built up with exactitude, and we call it “the mathematical mind.”

Bateman asks:

Is your mind made of routines that are alien incantations that you mysteriously “work”? Or is it understood, made up of independently cognized algorithms, which you can mull and interrelate, and in which you have earned confidence?


The reason I write anything on any particular day is usually opaque to me. Most of my alien incantations come from the mind-cleansing bombardment of a hot shower whose snippets I can sometimes reassemble into a cohesive message. I don’t ask why any particular topic occurs to me but this week my urge to promote computational thinking had a few sparks.

I’ll mention 2 here and another in Money Angle.

  • This was StockSlam week.Steiner had a vacation in the Bay Area so we used the opportunity to host the pit trading simulation in SF and Walnut Creek. I love doing these sessions to meet people, play games, foster in-person connections, and help participants viscerally feel the concepts I write about.

    The world of finance, trading, and betting is an amazing laboratory to improve your thinking and decision-making. Being forced to put a price on a belief sharpens fuzzy thinking.

  • A meeting with a local friendWhere I live in CA nobody talks shop (this is probably not true on the peninsula or showbiz land). Here folks people are obsessed with skiing (Tahoe this and Tahoe that and best season ever, yadda yadda) and mountain biking. I’m no adrenaline junkie and my Egyptian blood hates the snow.

    So I was surprised a) that a friend was actually in town and b) that they wanted to talk shop (kinda). This person invests in pre-IPO companies today but spent the past 20 years in software sales and the 90s as a software engineer. They reached out because they wanted to learn more about options. Not because they wanted to devote themselves to trading, but because they thought dabbling in options would help them be more methodical in their thinking.

    A few points they mentioned:

    • They felt that their computational thinking muscle had atrophied since their engineering days, especially with a life in sales. While they had developed strong pattern recognition and business acumen, they felt gaps in how they synthesized those inputs into decisions.
    • The founder of their fund seems to think in terms of options but uses a different language to describe scenarios. This reinforced my friend’s sense that this was a place they should improve.
    • They wanted to take a more hands-on role in helping their kids (who incidentally take chess lessons at my house) think rigorously and thought directing their own attention in that direction would help.

My responses:

  1. The grass isn’t greener. I was jealous of their experience.Those pattern-recognition inferences are inputs and can only be gathered by decades of reps. The reasoning part can be taught much faster. If you spent just a year in a trading/arbitrage environment you’d have a useful lens to carry with you for life. Acquiring a practical mental catalog of business models takes much longer. I believe I can take my brain and stick it in someone else (provided they had some minimum aptitude, desire, and work ethic). I can’t acquire the equivalent fraction of what they know in the same amount of time.

    [Obvious alert: this is why you try to assemble complementary teams. In Gauntlet, you want the long-range Archer, the healing Wizard potions, the Barbarian to deliver damage, and the Valkryie’s armor for protection.]

  2. We all get rusty.Despite years of trading and writing, when I read Agustin Lebron’s Laws Of Trading (my notes) I realized how lazy my own thinking had gotten. It put me right back in the culture and mind habits of prop firms in a way that reminded me that weeds of lossy heuristics were growing in my mental garden.
  3. I promised to send a list of posts to get the gears turningAs I sat down that afternoon to compile the list, I figured I should make it available to anyone who felt the same.

With that enjoy a new portal:

🧠Moontower Brain Plug-In

📖Learn

🏋🏾Practice


Money Angle

In a recent interview with Tim Ferriss, VC Bill Gurley admits:

If there was a scale of financial sophistication between one and 10, and you would say a really smart person in New York is an 8.5, the average Silicon Valley person on financial literacy is a two.

And it’s funny because they make fun of Wall Street, but it’s just out of ignorance, they don’t know anything.

Bill said it, not me (the transcript is worth reading for the full context but I’m not twisting him… those words are the spirit). I don’t know enough to have an opinion on this but I do find it surprising. Financial literacy starts at home and VCs don’t strike me as a cohort that rose from the gutter so either I’m wrong about the source of financial literacy or maybe poor kids play lacrosse after all.

Either way, the workings of money are abstractions like code. It touches almost every decision since it prices time (interest rates function as an exchange rate between time and money). It’s a basic life skill in an increasingly abstract, financialized world. Teaching our kids about it is basic hygiene.

Last night, we had our regular family dinner with my wife’s sister’s fam (4 adults, 4 kids — grades 1, 4, 5 and 7 plus another 4th grader who was spending the night). We usually go around the table asking each person about something they were grateful for that week or what’s something they tried at and failed (I know, I know it’s a bit cliche. These prompts do lead to provocative discussions and serve to put kids and adults on the same level).

But this time we did something different.

Yinh wanted to use the Silicon Valley Bank run as a learning moment. She started by explaining how banks invest deposits in longer-dated loans to earn a yield. To nudge the kids towards understanding the risk, she said the bank invests in loans that only pay back once a year. While not mechanically true, the point was to have them recognize the liquidity mismatch between the long-dated loan and the deposits that can be withdrawn anytime.

I taught them how rising interest rates cause the value of the loans to fall. But I also dispensed with mechanical accuracy in favor of intuition. I told Zak he plays the role of the bank. He loans me $100 and I promise to repay him $110 in one year. But then, immediately, mom asks to borrow that $100 from me but she’ll pay me back $120 in a year.

How should Zak feel? Well, sad. He’s going to get $110 in one year but since his mom is willing to pay $20 for a loan he could have lent her only $90 and still known he’s going to get back $110 in a year. Of course, this isn’t accurate interest rate math, but save that for a 7th grader. For a 4th grader, this delivers the point intuitively. [And for adults who think buying individual bonds instead of a bond fund somehow is less risky because they know how much nominal money they’ll get back, think through Zak’s position here — he is still getting $110 back but he’s definitely sad even though the counterfactual universe where he invests in a bond fund that gets marked down to $90 is optically worse.]

I was fortunate that my mother taught me about money. I can still remember my brain hurting when she explained a mortgage to me. It took a while to get my head around it. Remembering that keeps me patient — I’m grateful she persisted until it got through my dense skull. She didn’t push, she just repeated herself calmly every time I was frustrated “how does this work again?”. It sinks in eventually. If anything, the exposure will prime them to learn faster when they do encounter it down the line when the stakes are higher in school or real life.

[If you think my difficulty in understanding a mortgage was stupid, I got a better one for you. When I was about 12 or 13 an older kid told me a prostitute is “someone that gets paid to have sex with you”.

Sit down for this.

My mental model for “someone gets paid to X with or at you” was…a hitman.

I now believed that there was a person whose career was to have someone pay them to have sex with a 3rd party. Until then I had the impression that sex was a desirable activity but then hearing it connoted as something that is delivered as revenge or assault made me wonder if sex might actually be a gross punishment.

Dazed and confused is a fitting description of my existence so I’ve got that going for me and this blog.]

Money Angle For Masochists

We played StockSlam after dinner. The kids (well not the 1st grader) and adults were all into it.

There are 8 colors or shares that take a random walk over 10 rounds. The shares of the color that climb the highest are worth $100 at expiration. The rest of the shares are worthless. So you are trading a derivative contract (a future) not the share prices directly.

Purple is in the lead:

The rules are simple. You are mock trading in an open outcry environment. You start with 4 shares of each color and cash. It’s a free-for-all where you can trade with anyone at any price. You can bid, offer, or make 2-sided markets. It’s exactly what we did when we trained although simpler since we aren’t using options (although depending on the audience we will also trade options as side bets…”what’s your offer on the blue 150 call?”— if you get lifted, you can buy blue shares to delta hedge and isolate the vol).

The game is a deeply layered experience. You can just play for fun. It’s wildly energetic — we make sure everyone gets involved and there are gentle ways to do that, different personalities manifest in so many ways…some sling from the hip, some are shy or don’t want to open their mouths until they think they know the value of everything but then it all changes and you realize that approach won’t work.

But what attracted me to the game, beyond the fun, was how it bursts with trading lessons. Based on the audience we modulate the experience up and down. We give homework leading up to the event and bridge the rationale of the questions to insights embedded in the game. We connect real-life investing and trading concepts to the game (and honestly we don’t even get to them in these 2+ hour events…everyone wants to play not listen to lecture).

The single most powerful lesson though is one I harp on all the time — trading is about measurement not prediction. In the game, prediction is not even possible. The walk is random. But skill expresses itself strongly! Your ears pipe in pricing data so you can triangulate fair value and find aberrations. The visceral feel of playing skillfully is well-matched to the feeling of trading effectively in real life. When I pull you aside and ask why you did X or Y, a good answer will take the same form of sound trading rationale — “well, I bid 17 for green because red which is in the same position just traded 20 and I know Sam bought a bunch of green last round for 12 and is looking to flip a quick profit”. Your transacting like crazy but you can kind of tell without stopping to count if you are making or losing money when you get into the flow.

Getting In The Trading Headspace

Let’s pose some questions and entertain some scenarios.

At the start of the game, all the colors start at 100. I might start by just throwing out a 14 bid for red or a 9 offer in yellow just to see or a 16 offer in green, etc to get a read of the thought processes when the game is a blank slate.

Let’s look at a scene futherer along:

Suppose the following montage represents the situation in the pit:

Purple: 28-32

Green: 20-24

Blue: 20 bid

Gray: 10 bid

Jane yells “Pink/orange 1×3…even bid for the pink. I’ll buy pink, sell 3 orange for even”

What do you do?

If you sell the 1×3 you will get long 3 orange and short 1 pink. You can then turn around and lift the 1 green at 24 while hitting the 10 bid in the gray 3x.

What’s your net position:

+3 orange

-1 pink

+ 1 green

-3 gray

Chunking the risk:

  • You’re long 3 orange and short 3 grays (they are worth about the same, as they are 96 and 95 respectively in the race).
  • You are long 1 green and short 1 pink (again worth similar amounts based on their race position)

The risk on these positions is basically a wash…but you collected $6!

[You sold 3 grays at $10 each and bought 1 green for $24. The pink/orange 1×3 traded premium neutral]

If you keep doing positive expectancy trades and manage to not get too unbalanced in your positions you will have a high Sharpe and be profitable by expiration. If you just try to load up on the color you think will win, that’s a zero expectancy strategy that’s high risk/high reward and will have a garbage Sharpe over many games.

As we play the game I might come over and nudge you:

  • “Hey, do you think the gray bid had any room? If you can squeeze an 11 bid out of them then you would have collected $9 instead of $6.”
  • “What if the gray bid was thin and you could only sell 2 on the 10 bid? Do you see how liquidity and gauging the size on the bid/offer is important? You are now ‘hung’ on 2 grays that you couldn’t offload. Is the trade still worth doing if you have to hit a 9 bid on the remaining 2 lot for an average price of 9.33?”
  • “The green bid was only 20, you could have bid 22 and maybe the 24 offer would have stepped down and offered 23s or better yet just hit your mid-market bid.”
  • “Blue is 20 bid…maybe those oranges and grays were kinda cheap relatively and the good side of the trade was just buying the orange 3x via the first ratio trade but not locking it in by selling the grays. Don’t do a trade good by $5 and then do a trade bad by $2 to lock it in if you don’t have to…you have to maximize when you have the best of it because you may find yourself needing to give up edge sometimes to manage risk”.
  • “With the green offered at 24, maybe you can dangle a 22 offer in the blue…if you get lifted turn around and take the greens. You’ll have legged the spread for 2…maybe you try to offer out the pink/blue spread at 7 fishing for a 5 bid. Paste those and your net position is long green/short pink for a $3 credit!”

This is trading.

Replace colors with option strikes/maturities and all the many combinations of vertical spreads, synthetics, straddles, and underlying… churn all day, and let the chips fall where they may.[see Mock Trading Options With Market Makers]

If you trade enough with a positive edge the expiration results are just noise — you win some, you lose some. The p/l over time converges to your edge.

Knowing the arbitrage relationships in options is the same as knowing that the field of colors can’t be worth less than or more than $100. Today we measure fair value from liquid consensus using machines — in the game we gather consensus by listening. In the pit, it’s loud and busy and orders are flying around everywhere. You learn to focus attention on what matters. And that changes depending on the context. The same is true in modern trading.

Today we enter trades with code or mouse clicks not vocal cords but the concepts are the same. That’s why prop firms still use mock trading to train. The arena is a Socratic forum that opens up conversations about practical scenarios. It’s like having a poker coach press you on “Why did you call that bet? What did you think they were holding? With what odds? If you think they just caught a 2 pair with that Jack of clubs on the river, do you think they really would have called the big bet on the turn with a low pair and no draw?”

Mock trading in the presence of an experienced trader is an opportunity to debug your thinking.

This was Friday night:

And then Saturday night with the family:

rea events ranged from 10 to 25 people. I’m still in awe of a 6th grader who could just see the Matrix. The kid was fast and a total shark, preying on people that were still getting their bearings. After the game, he had opinions about shifting some of the probabilities in the algo and adding skew. I asked his mom if he was coding or using Excel and she said “no, not yet”.

”Umm, give him to me”. With some tools for expression he’ll be off to the races!

Otherwise, with respect to the game, I will share more as appropriate. We did have a videographer at all the sessions so at some point there will be more to see. In the meantime, if you are interested in having us do a team-building or educational seminar at your office, conference, or school hit me up and we’ll figure something out. By the way, the game shown above is just one of several games we actually trade on. The attendees will remember their favorite “bunny” I’m sure.]

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