Moontower #196


I’m just writing from the hip today about reading.

Since  my first kid was born my reading has cratered to like 3 books a year. While Zak is a convenient scapegoat, the truth is moving to CA is the true culprit. I no longer had that 45-minute E-train commute from Long Island City to the NYMEX. That trenta-sized ice coffee with a paperback was a luxurious start to the morning before switching into literal arena mode (shout out to the main character of fintwit this week).

Zak is 10 and I’m emerging from the fog. I’m on my 12th book this year, participating in my first ever book club and likely joining another. The Kindle app has also helped — the phone is morphing from a pile of Instagram wedged between slices of group chats into a book sandwich (separate thought, but a great use of LLM tech would be to classify a text message into time-sensitive or not and only send notifications for the former).

This year I’ve read:

I’m currently reading 3 books simultaneously:

  • Tomorrow, Tomorrow, Tomorrow

    This is for the book club. I’m really enjoying this novel.

  • More Than A Number’s Game: A Brief History of AccountingThe book traverses history by examining a different case study per chapter. I’m early in the book, but so far it’s full of highlights.

    Why am I reading this?

    Broadly speaking — accounting, from GAAP to mental accounting, is a striking topic because in the spirit of “we manaage what we measure”, it is the seat of so much decision-making extending to everything. Hell, business accounting is just a narrow application of measurement at large which properly done should consider counterfactuals, opportunity costs, and at least second derivatives.

    The simplest non-obvious questions are like: Do Uber drivers deduct their car’s depreciation from their hourly wage (I see you Jim)? How many businesses actually suck once you properly adjust for maintenance capex or what Buffett calls “owner’s earnings”?

    And much more complicated questions wrangle with — just how much greener is an electric vehicle than a fossil-fuel vehicle (suspect it has a lot to do with where these vehicles are located so you get the non-sound-byte-friendly answer: “it depends”).

    Another thought: While my interest in Georgism was sparked by normative concerns, the most interesting part of it comes from its accounting — specifically the philosophical basis for distinguishing land and other natural resources from capital. It’s an amazing reminder that the connotations of big words like “capitalism” are loaded with design choices in how we do accounting and none of it is a natural law like gravity. Economic policy is not physics. How we understand it is tightly and invisibly wound around our basic accounting definitions.

    (There is nothing about capitalism which suggests that we should account for the land and sky differently, but we do. Which implies that how we treat land is not resting on the principles of capitalism. Which strongly suggests that painting changes in land accounting as anti-capitalist is a self-interested sleight of hand. The Georgist approach actually strikes me as far more in the spirit of capitalism. I sense plenty of room for thoughtful counterpoints but the average reaction to Georgist principles are just the confessions of people habituated to regurgitating convenient viewpoints. And that’s me trying to be nice.)

    If you care to appreciate what this means, it’s best to observe the building of an economic framework from first principles. Give it a try.

    Go to: and rip thru the following sections:

    📒Defining Terms

    👷🏾‍♂️Wages, Capital, and Labor
    🔀The Laws of Distribution

  • Life in Half A Second by Matthew Michalewicz

    Matthew is a Moontower reader and sent me a signed copy. It’s self-help kind of book which is a style of book you have to force me to read. I actually don’t relate to a lot of the thinking but I definitely glimpse some bridges to my own. And this is helping me flesh out some thoughts that will make it into Moontower I’m sure. Plus, being able to discuss it with the author is pretty dope. We see eye-to-eye on a lot about life so by exploring the parts I struggle to relate to should stimulate a wider perspective.

Books I’m reading aloud with my kids (as I risk afflicting them with the “read several books at once” disease)

  • Journey To The Center of the EarthThis is not an easy read, so it’s a great opportunity to see what they understand and act as translator. I’m playing with this idea of having them read books at their level on their own, but I read harder books with them. I have a little story made up about how this gives them different “powers” because I think creating some magic or mystique about the beauty of reading will give them an inexpensive pleasure and sense of appreciation throughout their lives which also happens to have instrumental value.
  • Man For All Markets: Biography of Ed ThorpEd and his life are wildly inspirational. He became wildly successful (wealth, family, friends, health) because he was super-curious, playful, independent-minded, and persistent. Money was a byproduct, not something to optimize for. Nearly all the people I find inspirational fit this mold. Money is great and I definitely want more, but never at the expense of boring myself.

    The unrelatable part of Ed’s story is he is one of the towering geniuses of the 20th century.

  • Hitchhiker’s Guide To The GalaxyI’m early into this and been meaning to read it for awhile. So far so good. Literal LOL material.
  • A Wrinkle In TimeThis has been a slog to be honest. Not sure we’ll finish it, haven’t touched it all summer.

What books are next

These aren’t in order. I impulsively pick in the moment. Fiction books will come from the book clubs so they are TBD.

  • A Theory of Fun for Game Design by Raph Koster
  • Alchemy by Rory Sutherland
  • World For Sale: Money, Power, and the Traders Who Barter the Earth’s Resources
  • Cash Rules by David Hale
  • Dreamland: The True Tale of America’s Opiate Epidemic
  • Dopamine Nation
  • Chaos by Tom O’Neill
  • Killers of The Flower Moon
  • Guitar Zero (re-read)
  • Play Anything: The Pleasure of Limits, the Uses of Boredom, and the Secret of Games

Technical books

  • Advanced Portfolio Management: A Quant’s Guide for Fundamental Investors (I believe this is standard-issue at Citadel)In the spirit of holistic accounting, I’m interested in pertinent benchmarking and proper performance attribution. This book should help.
  • Systematic Trading by Rob Carver
  • Positional Trading by Euan Sinclair
  • Active Portfolio Management by Grinold & Kahn
  • I’m also reading a highly technical manual on derivatives that is formal while covering practical minutiae from the trenches — many that are rarely or never addressed in the canonical texts. This one is not yet (and may never be) published — written by ex-SIG friend, currently in a senior role at a large MM. I keep urging the author to publish because I selfishly want to cite from it.

Money Angle

Myself and a few members of our local club are going to do a financial and investing literacy series for the member families. We put together a first draft syllabus this week and as things move along I’ll share here. Perhaps we’ll even turn into an online series. I’ve been working on one focused on the investing side but it’s only a WIP because of priorities (

The one we are doing for the club will be highly practical drawing on the experience of a financial advisor, a retired Point 72 PM, and some option trader crank who writes on the internet. (Topics will range from “what is a bond” to bringing in experts to talk about how to pay for college)

As I was poking around notes, I re-read some of Byrne Hobart’s Capital Gains missives which is a series devoted to finance education (although the material isn’t quite 101 — it’s more of a redo of 101 for people who have already gotten a finance education. I hope Byrne doesn’t mind me saying that.)

Here’s one that stood out:

The Capital Asset Pricing Model: Risk, Reward, and Reasons (Capital Gains)

Some excerpts/teases:

The temptation is to think that if risk and reward are correlated—if you can reach for higher returns by selling your investment-grade bonds and replacing them with stocks, or selling your large-cap US stocks and replacing those with wilder emerging market stocks—that all forms of risk-taking are rewarded with higher returns. But this isn’t true: the expected return of a single stock of average volatility is the same as the expected return of the market, but the volatility of one stock, compared to a diversified portfolio, is much higher. And thanks to the relentless math of “volatility drag,” i.e. the observation that you don’t offset a -50% loss until you’ve made a +100% return, the expected overall outcome from this particular form of risk-taking is negative.

And there are other forms of unfavorable risk/reward tradeoffs: paying higher fees for exposure to the same asset class, for example, is a straightforward cut to returns with no attendant reduction in risk. In the general risk/reward tradeoff, there are some extreme cases where things don’t work as planned: the longer-term a bond is, the more it’s a bet on interest rates, and the more it’s excess return is compensation for taking interest rate risk. But 30-year bonds don’t get returns quite commensurate with their risk—because when bond portfolio managers want to make a big bet on rates, that’s what they have to bet on.

How can we square these observations with the fact that many investors have achieved great success through concentrated bets on a handful of positions? One obvious answer is that some of them are lucky; “lottery ticket” is an accurate pejorative term for assets and strategies whose risk isn’t commensurate with reward, but lottery winners do exist.

However, there’s a subtler answer…

There are many mediocre tradeoffs between risk and reward, where you can get the same mix of them in different amounts. And there are some bad tradeoffs available, with incremental-reward-free risk. To get a good tradeoff, you need a good reason to expect it: some justified belief that there’s a particular asset that’s mispriced, and a good meta reason to think that nobody else has considered it. In a competitive market, you need not just a theory about the asset in question, but at least some kind of theory of why your competitors haven’t spotted it. Yes, “I’m a better investor than they are” is a theory—but do any of your competitors pick stocks despite consciously thinking they’re bad at it? Especially in an environment where cheap index funds are available, you should assume that the average market participant is about as self-confident as you are. And one fun implication of this is that the best returns accrue to people who think they’re less skilled than the average stock picker, but skilled enough that they shouldn’t leave the whole process up to Standard & Poors.

Which is not to say that investing by picking a small set of smallish, high-variance companies, watching them like a hawk, and enjoying long-term outperformance with some painful dips is a bad trade. It can be a very rewarding hobby! But the opportunity cost is defined by the average performance of index investing. So stock picking ends up being like many other hobbies: it takes time and effort, and if you’re very good at it and somewhat lucky, you might break even.

Money Angle For Masochists

The new post Short Where She Lands, Long Where She Ain’t was incredibly well-received this week so I’m hopeful it’s doing what I intended — prompting investors to match their trade expressions with what they actually think the future outcomes look like. Sometimes you use a mallet (“just buy the stock”) and sometimes your view demands a scalpel (“if the stock is not higher then it’s much much lower”) and that is the realm of options.

Here’s a re-print of the insights and answers to questions I anticipated:

🔭High-level insights

  1. You want the stock to land near your short strike or away from your long strike. Over a large sample of trades, if the stock expires near your long strike more often than the theoretical distribution then you will lose. If it lands there less often than theoretical, you’ll win on average. For short options, the opposite is true. Even though the options in these sims are perfectly priced, there is still noise because we are still drawing a sample.
  1. Put-call parity is iron-clad. You are either long options or short options. These sims let you see that whether you delta hedge a call or put the outcome distribution is the same. All that matters is whether you are long or short an option, not the type! [My professional risk software didn’t even display calls vs puts at the high level. It just summed total options per strike. You could drill down to see if your exposure was calls vs puts because it mattered for funding and pin risk reasons.]
  1. “Pay me $10k up front and I’ll flip a million-dollar coin with you” That’s options market-making in one line. Remember these sims are perfectly priced options. Now imagine you have a trading business and net a penny of option per trade (this is a very generous assumption — margins are often smaller than this). In the example of the 110-call with 8-steps until expiry you’d be making a penny of edge with a standard deviation of 88 cents! Of course the Sharpe ratio at the trade level isn’t the same as the Sharpe ratio at the strategy level. Because edge scales by N and risk scales by square root(N) you can have a great business if you do LOTS of trades while maintaining that edge. The flip side: if you don’t do lots of trades your results are noise. Welcome to epistemological nihilism.


If you are not a delta-hedger, but trading the options outright for direction does this matter?

Sure does. If you buy a call because you’re bullish, your alternative could have easily been to buy the equivalent delta worth of stock. If the stock then goes to your long strike, you lost not only your premium but the foregone return on the shares you would have owned! This reinforces the point that options require you to be right on direction and timing/volatility (time and volatility are intricately linked). Remember, options are priced for specificity. The leverage is amazing if you call the outcome and timing correctly, but like a parlay, you will often lose if you get any part of the bet wrong. Remember the put-call parity insight — no matter what you do, you are trading volatility. Without a view on that, you shouldn’t touch the options. If this doesn’t make sense, you don’t understand options. The house is more than happy to have you delude yourself in the noise I described above.

You are a market-maker and see a giant flurry of call buying in the context of bullish news. You decide the buyers are overpaying — the prices are implying a volatility your process has deemed as “excessive”. Do you hope the call buyers are right?

As a market maker, you try to understand your counterparties. The prices people are paying (which imply a volatility) and strikes they are chasing give you a sense of how much conviction and how far they think the stock can run. If you suspect they are bidding “too much” for these calls you will sell them and you will buy the stock yourself to hedge the calls. What am I rooting for and what am I worried about? Let’s start with my 2 primary fears:

  • The stock acts like GME and just explodes higher. No vol that I sell is high enough. It rips thru my short strike, it keeps going, it’s hard to buy, gamma squeeze, you know the drill. That’s the obvious risk.
  • The stock gaps down through a trap door. No liquidity. I collect the option premium but I ride my long shares into the grave.

What am I rooting for? The stock continues to go higher, but slowly. The call owners feel the theta breathing down their necks and are anxious to monetize. They got the trade thesis right but…they overpayed for the options. The market makers have them just where they want them. If they are aggressive, they will understand that there is a supply of calls being held by weak (as opposed to diamond) hands and start offering the volatility down themselves, accelerating the losses felt by the option longs. It’s a game of chicken and the first option owner that offers is the tell. They’re going to throw in the towel. As the market maker this is fun. I win on my long shares and I will get to cover my vol shorts hopefully at cheap levels. The way I think about trades where the counterparty is using the options for direction is whether their being correct on direction is stabilizing or destabilizing. In 2021, GME going up further was highly destabilizing. It didn’t make sense. It was “irrational”, “forced squeeze”, etc. A destabilizing move is a liquidity vacuum. Once something doesn’t make sense, there is a phase shift in sentiment from logical thought to the next print is going to be driven by the most desperate account. Death spirals are divergent, not mean-reverting processes.

On the other hand, a stabilizing move is one that occurs in the direction of consensus and makes sense. Think early 2022. Hedge funds had actually degrossed ahead of the sell-off and option skew notoriously underperformed going from expensive to multi-year lows during the sell-off. Fund managers were well positioned for the sell-off. Here’s Financial Times quoting Benn Eifert…

Option manager called the sell-off the most telegraphed:

There are always some people caught unawares, but the central bank pivot from “it’s transitory” to “we’re going to nuke inflation” was petty well-telegraphed, and the impact widely expected.

My discretionary sense of whether a move is stabilizing or destabilizing plays a large role in how I manage an option position for the name. That sense comes from the semi-conscious process of pattern-matching how the market is positioning, how aggressively and what the broader news context is. I’ll add one bit.

If I have a sizeable short call position, my experience tells me that I should be nervous about the downside. If the market is smart (and it is), it will bid for calls when it understands that the distribution has a more positive skew. The counterbalance to a more positively skewed distribution is that the underlying is more likely to go down in priceAnd if the options are bid because the market understands the distribution then that is usually how I’m going to get hurt. Owning long deltas on a sharp down move. And here’s the salt in the wound:

When I sold the expensive calls I likely bought some other option to hedge the vega. If the skew shifts to the calls, that means I probably own puts which would have begun to screen cheaply. The problem with this is the down move is expected and stabilizing. which means the implied volatility will fall.

This is diabolical.

The stock is going away from my short calls, towards my long puts and I’m carrying long deltas against both types of options. Pain parade.

I have seen traders blow out in these scenarios. Long vol and getting longer vol as a name collapses on a stabilizing move. And every time that vol compresses on a downtick, this position “decays longer” (vanna for the nerds out there).

If you take anything away from this — your assessment for how vol will react is heavily dependent on how far and fast a move can be before it phase shifts from stabilizing to destabilizing or vice versa.

[Whisper voice] The kinks in the skew are a clue which means the right way to iron them out is with a butterfly not a vertical spread. Unless you haven’t been trading options for years, that will mean nothing to you and it also means you are doing life correctly. Take a bow.

How can I use this knowledge to shape trade expressions?

If you’re bearish, consider buying calls to replace part of your long position. If the market falls and they expire worthless, you are happy.

You can then scoop hard deltas at the lower price.

In other words, you were bearish which is highly correlated with the idea that volatility is going to increase. Remember you want to own options where the stock ain’t going. Think of a very expensive 2021 type market — if the expensive stock keeps going up it’s a surprise. It’s destablizing. So the calls will hold up well.

But if the market does tank, you’ll be happy you switched your long shares (or what I call “hard deltas”) to calls (ie “soft deltas”)

You want your hard deltas pointing in the direction of the most likely scenario and your options pointing in the direction of the destabilizing scenario that probably isn’t going to happen.

This thread harps on this a bit more.

I have a hunch my boss doesn’t really understand options but he trades them a lot. Is there a way to tell?

Does he like to say “I’m selling this strike because it’ll never get there”?

That’s a dead giveaway that he’s trading options without understanding their nature. This misunderstanding leads to decisions that are 180 degrees opposite from their thesis.

Why? conditional probability — a cheap option that hits is nitroglycerine because the cheapness signified that its the seller used “it’ll never get their logic”. Their false confidence in that assertion means they underestimated the scenario when sizing their risk. The move is deeply destabilizing because they are offsides in a big way and need to cover.

A short-circuit in Bayesian reasoning displays itself when put-sellers say “I’ll be happy to buy the stock if it gets there”. They are projecting a state of the world where only this one asset changed in price and everything else stayed the same. Or the investor who sold bond puts assuring us they’d “be happy to buy bonds if they hit a 7% yield.”

Well, what if they only hit a 7% yield when inflation is 9%?

I’ll be repetitive — this boss is the same guy who sells calls because he’s bearish.

Bro, you don’t want to be short options away from where you think the stock is going — you want to use hard deltas to point that way and own that option as insurance to put the trade on with conviction.

☮️Stay groovy!

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