Option Theory As A Pillar Of Decision-Making

Understanding Options and Decision-Making (Thread)
@HideNotSlideIn an old Barron’s Roundtable, Jeff Yass, the founder of SIG had strong words about how fundamental option theory is to decision making.

Of course this sounds self-serving, from a guy who understood options as a young teen. But it reminds me of a more famous investor. Warren Buffet. I’ll rely on readers to find it but I remember Munger saying that Buffet was already thinking of options at a precocious age. While Buffet calls derivatives “weapons of mass destruction” his own investing history shows an explicit use of options (his put-selling maneuvers are well-documented…and critically path-resistant since they are not marked-to-market). I’m not a Buffet expert, but his use of “insurance float” sure looks like something that came out of the mind of a derivatives trader.
- The Moontower Volatility Wiki is growing every week due to submissions from the online vol community. It also includes every post I’ve written on options, many of which try to use options theory to understand markets and think about probabilities.
- Decision-making is a practice.
  - A pillar of sound decision-making is thinking in probabilities or as Annie Duke’s book is titled, Thinking In Bets. Here’s the notes I took on an interview with her which captures the essence.
  - This weekend I came across a great post by in the same vein by Jonathan Bales The Time I Sold Furbies For Money. I especially liked the bits about Belichick’s non-punt, and poker pro Phil Laak about learning what “5% feels like”. [Phil is a good friend of some friends I made in the options game so it was especially cool to see his thinking turn up in that post].I’ve previously commented on the neat analysis Bales himself did on the question of when you should “work for free”. You should follow @BalesFootball if you want to sharpen your “thinking like a gambler” sword.
A Personal TakeI added thoughts on my days at SIG in response to the Yass thread. Here’s the text:
When I was a Susq I heard Jeff speak a few times. It was always engaging.

They were savage in my days there but the doubling down on tech and brains thru the years probably makes Jeff the richest dude in the world you never heard of (unless you look at pol donations, then you know). One of the talks was on the primacy of markets (Yass is an extreme libertarian, free-marketer, no fool should be allowed to keep their money type. Appealing views to many traders, esp when they are young). This post was one of his market lessons: Dinosaur Markets.

One of my interactions with Jeff was a mystery to me:

I remember when I was a 1st year mm on the Amex and I reported a giant trade that got crossed in AIG on the internal chat. I got a dm. “Pls call”. It was from Jeff. I was never so scared. Was I supposed to break that cross up? I called Jeff from an Amex phone and he just asked me for the trade details. Implied vols, who the broker was, what bank crossed it. I told him and he abruptly hung up. That was it. Still don’t know why of all the trades I’ve ever on reported why that warranted a call.

Other times I’ve heard Jeff speak was on why the dot com bubble was not an example of market inefficiency and it goes back to understanding option theory and the relationship of volatility to positive skew and what drives volatility. I’ll write about that one sometime.

He also speaks to every trading class for an hour that goes thru the 3 months of theory and mock trading in Bala Cynwyd. In my class he talked about career risk with NFL coaches affecting decisions (he defended an oft- mocked Barry Switzer decision to not punt)

I will always be thankful for having worked and learned at SIG. I really didn’t have any business being hired there (2000 was the largest cohort bc $ was raining from the sky. They needed warm bodies to pick it up) and I think I’m proof that traders can be shaped and aren’t born. [By the way, this is very much why I try to teach what I’ve learned. Hopefully people smarter than me can build on it and let me invest in them 🙂 ]

Incidentally, the head of HR who hired me gave important advice I always remember. When I explained I had a few higher offers she said:

“You’ll be rich whatever you choose. Decide who you want to work with.”

She knew SIG held the nuts.