Innocent Fraud

The last time I remember saying more than a sentence about macro was about 2 years ago.

Before that the only real dive into it was reading Jesse’s outstanding paper Upside Down Markets. I read it 3x. It’s the length of a short book so I did a thorough breakdown of it here if you want a condensed version.

A highlight of Jesse’s paper was the use of the Kalecki-Levy “sectoral balances” accounting framework which offers a very organized way to think about economic flows. That framework gained awareness as MMT gained prominence in economic discourse.

MMT or modern monetary theory is called a “heterodox” economic theory. This has nothing to do with what kind of theories it likes to have sex with but just means it’s outside the mainstream. It’s controversial because it’s interpreted as this hyper-Keynesian excuse for the government to spend. Valid concern. But that has less to do with MMT’s descriptive power and more to do with its politics. That said, this problem applies to macro in general. The error bars around macroeconomic theories are far wider than the political battering rams of policy. Policy is always distributional — there are winners and losers. Those contested grounds hold far greater weight to narrow interests and individuals than the economic statistics that roll up to high-level macro summary. [Most economic arguments are politics in disguise.]

I have a friend who manages a pool of capital for a HF-turned-family-office. He’s creative thinker to bounce ideas off. Inquisitive thinker who reflexively considers many angles to a problem before even speaking. When we chat he never asserts anything. And he’s one of those listeners who makes you nervous. His question-to-opinion ratio is like 100-1. The opposite of the incurious, overconfident Mr. My Ways that are overrepresented in finance (which is foremost a sales industry).

I say that because the book I’m going to recommend came from this friend and our back-and-forths on Whatsapp. It’s definitely not a book I would have read if this guy didn’t recommend it. I’m really glad I read it. But for reasons that are probably not why most people pick it up. I’ll get into that but first, the book is called:

The Seven Deadly Innocent Frauds (free download)

There’s a blog post sized version.

And my Kindle highlights.

The book is by the “father of MMT” Warren Mosler.

Reading him is a surreal experience because the extent of conventional misunderstandings of how money works at the macro level seem both comically and tragically disturbing. I’m not talking about his suggestions which are totally contestable but the revelation of how people in power don’t even understand the mechanics of banking and money.

Watching the crypto grifters “do macro” is even more ridiculous when you discover how many fallacies they’ve inhaled. Although the “taxation is theft” argument they spout is closer to the truth than not. This is not a vote for anarchy but the sentiment puts a finger on a strong feeling one gets as they read this short book — just how deeply coercive the contract between a government and its people are. That feeling is cemented as Mosler beats you over the head with a basic identity in a fiat monetary system—taxes have nothing to do with funding expenditures. Zero. (He actually shows this through an experiment you can do at home with your kids to show it…and of course I will be doing it, muahahaha).

Anyway, I recognize that MMT is left-coded and the finance bro who describes himself as “socially liberal and fiscally conservative” would rather compliment a dude on his veiny calves than read a book by Mosler. So let’s see if I can pitch the book with the right hooks.

Here’s why you should read it:

  • The “sectoral balances” framework has been credited for the late British economist and MMT influence Wynne Godley’s forecasting track record.
  • Jesse, who is anything but an MMT fan, used that framework to write the prescient Upside Down Markets paper.
  • Mosler is a trader first. He is a fund manager whose successful arbitrage style of investing shaped his first-principles understanding of how the economy works. The book is short. The 7 “deadly frauds” are covered in about 50 pages and his career memoir comprises 25 pages. He catalogs a fascinating list of trades, including several pioneering bets on lira-denominated bonds, GNMAs, bond futures and cheapest-to-deliver pricing (there’s a neat side-story to those because they were a release valve for the Hunt Brothers’ silver squeeze profits, and subsequent COMEX governance shenanigans that floor traders are aware of). The rich trader to economist to (attempted) politician arc is not one you see every day.
  • The book is easy and fun to read. Depending on how resigned to cynicism you are, you will laugh as he recounts conversations with famous policy makers and politicians that reveal an unwillingness of prestigious people to get their hands dirty and learn. In some cases, they are quite open about the fact that they are captured by audience. Incentives. It’s always incentives.
  • It’s worth commenting on Mosler’s leftism. It’s an easy box to put him in through the lens of how how left and right are oriented on the chessboard today in common discourse. But if take a longer view of orientations, his strong pro-markets/small government posture is a degree of sensible nuance that is easy to gloss over in an era where we forward articles after only reading the headline. I think his MMT-flavored recommendations sound like “big government” because his implicit demand is that it is impactful and assertive in a smaller but more focused and well-calibrated role.
  • You’ll walk away realizing how so much of macro is a series of “fallacies of composition” (he uses the paradox of thrift as a classic example which I always appreciate). In fact, the book makes macro seems quite easy. Not as in “I now get it”. I still have lots of questions. But you find that macro effects have a limited amount of outcomes when you see it reduced to accounting identities. To be repetitive, you realize just how much most macro discussions are political ones because they deal with the “distributional effects”. The same macro outcome can map to many ways of slicing the prosperity pie in America and that’s really the stuff we argue about. We argue about it as if x or y is good or bad for the economy. By analogy, substitute “league” for economy — nobody cares what’s good for the NFL they are really just wearing team colors.Maybe that was the most enduring takeaway from the book if you just read between the lines. Whenever you hear people argue macro, just smile and nod. Macro opinions are nothing but political mood rings. You can tell what color they’re feeling when they open your mouth.

A few admin notes about the book:

  • Like I alluded earlier, the book is 100 pages. The first half covers the 7 deadly financial frauds, the next quarter recounts Mosler’s investing career (he’s still active), and the final quarter of the book outlines policy proposals informed by his views. He ran for state office. I barely skimmed the last part.
  • The book was written in the wake of the GFC. Our problems today look like the opposite of what we were facing then but don’t worry we’re equally stupid.

Personal bias note:

I’ve admit of my George-pilling (this was one of my favorite explorations of a topic in economics) and preference for land value tax to replace much of our overly complex and unjust tax system. I think Mosler’s economic thinking dovetails nicely with Georgist ideals and first principles understanding of economics.

One last thought:

While a deeply enjoyable read it makes the world less joyful to look at. We are bombarded with innocent frauds* because we are lazy and it take effort to learn things but no effort to parrot.

*An “innocent fraud” is a term by John Kenneth Galbraith that inspired Mosler’s title. It refers to misunderstandings that are “sustained by conventional wisdom”. Now you have a term for those crimes of laziness that necessitate yet another buzzy term: Brandolini’s law.

The “meaning of life” is a distraction from the present

Today’s confession — there is no “meaning” of life.

It sounds harsh.

But you know what would be even more harsh? Believing that there is one and not knowing what it was. Like you were born into an escape room with a single key to the exit. The clock starts when they cut the cord. You can ask for hints but none of the people who respond through the intercom know anything. You wouldn’t know that based on their confidence of course.

If “why” is so important, I think the best we can do is make our own meaning. Even this feels like alms to a story-hungry mental apparatus adapted for mundane survival needs but is easily hijacked by cosmic inquiry.

You’ve heard of American exceptionalism. Maybe I’m just underwhelmed by human exceptionalism. It would be easy to blame the cosplay of our current political hour but that’s a Budweiser commercial in the longest-running show in history — ‘the cruelty of man’.

I watched Blackfish last month. With only enough emphasis to set the scene, falling far short of its profundity, the narrator described orcas’ communications as indicative of a distributed but coherent consciousness amongst members of a pod. Like a Vulcan mind-meld. Even if this is just a possibility, I cannot shake the sense that humans, rather than occupying a “mandate of heaven” (brb gagging myself with a notebook spiral) are just a parallel timeline written daily through nature’s trial-and-error.

If you’re religious or a “I don’t practice but have faith” or however you self-identify this is not a challenge to you. I wouldn’t dare. I have nothing to add in the face of all the brilliant, earnest, skin-in-the-game individuals or groups who have argued for or against any particular paradigm for our relationship with the unseen. If you feel a certain way you have your reasons. Maybe rooted in logic. Maybe a sensation. They are inviting as matters of discussion not prescription (whether this is a convenient cop-out or pragmatic maturity is left to the reader’s prism).

But to not be called in the direction of such meaning, also rests on reasons. I haven’t felt or seen what you feel or see. And if I’m supposed to seek until I am “found” and thus imbued with meaning, the spirit of such a requirement sounds like an overly specific morning routine. Neither cold plunge nor cathedral holds the key.

Similar to the mysticism of believers, my sensation of “no singular meaning” is mostly a matter of faith not logic.

[There was a phase in my life where I tried to reason to beliefs (as opposed to our default mode where we believe then post-rationalize — an impulse I believe is only resistible in the context narrow, instrumental inquiry). Depending on what you think information is good for, you might agree that being wrong a lot has the useful property of limiting your confidence on edifices built of logic. This is an elementary insight. After all, logic derives from assumptions so there’s always garbage-in, garbage-out risk. It’s easy to understand that on the cerebral level but internalizing that lesson takes practice. Incidentally, a discretionary trading career is one that constantly assaults your epistemology. You think your logical but the chance that you get every link in the chain from idea to trade expression is small (risk management is about unloading intolerable consequences from the inevitable chain failure). Trading hurts. Pain is a useful teacher.]

I say that because I don’t truly understand how I landed on my outlook. I think I’m just unsatisfied with any answer to the meta-question, “how could it have a single meaning?” Or maybe I just haven’t heard enough answers to that question.

I also wonder how other people land on theirs. It would make for a fascinating interview series to ask people what they believe the meaning of life is, or their life specifically…but the most intriguing part would be the answer to “how did you arrive at that belief”?

(If the answer to the “meaning of life” is the biological retort “to procreate” that’s a dead-end in the same way that the answer to “why do you practice freethrows?” leads to “ok fine but [follow-up why]”)

With the personal musing out of the way, here’s an essay that resonated for obvious reasons

The Meaning Of Life Is Absurd (11 min read)
Lawrence Yeo

Excerpts (emphasis mine):

Ironically, knowing that life doesn’t come with a grander meaning allows us to access the things that really do make life meaningful. This truth helps us realize that the big existential questions of life are not where the answers are; instead, this very moment in our small corner of the world is all we really have….

The questions of “What does it all mean?” and “What is my purpose?” are things we ask when we’re not plugged into this very moment. When we’re paying close attention to the project we’re working on, the book we’re enjoying, or the time we’re spending with our loved ones, then we’re not searching for meaning; we already have it….

In this futile pursuit of escaping the absurd, nothing will ever be good enough because we are always chasing an elusive grand narrative, our overarching meaning of life. We will forever be chasing our own tails, wondering when the hell the universe will answer our individual calls for purpose.

From the creator of Rick and Morty, Dan Harmon:

We have this fleeting chance to participate in an illusion called ‘I love my girlfriend’ [and] ‘I love my dog.’ How is that not better?

Knowing the truth, which is that nothing matters, can actually save you in those moments. Once you get through that terrifying threshold of accepting that, then every place is the center of the universe, and every moment is the most important moment, and every thing is the meaning of life.

The theme of “the present” has shown up in the last couple Sunday writings (and while they were just tangential to the main themes they were the lines I noticed were most shared. I don’t know if it’s a sign of our distracted times or an evergreen battle but people are thinking about it.

From The Gasoline of The Internet:

The whole “what you need” discourse is a distraction from the plain truth — there is an “arrival” fallacy at play. It’s very well documented across the board. Win the championship, celebrate one night, then feel letdown. Living in the future (or past) sucks. Never overdose on hope or nostalgia.

I don’t think about a “number” because if you hit it you still have to contend with what you’d do with your time. You should stop pretending that is a problem you acquire when you “arrive”. You have that problem right now.

From Status Symbols:

I’ll tell you what impresses me broadly.

People who look forward to Mondays. People who struggle to sleep because they are so stoked to be awake. This is a person who excels at something they enjoy and has the opportunity to do it. It doesn’t mean their life is free of things they don’t want to do. But their energy is directed towards activities that adequately solve their earthly needs for food and shelter and well-being needs for self-expression & autonomy.

This is messy.

Nobody is “arrived”. You’re always en route.

But it’s the most liberating thought if you let yourself take it seriously.

I love McConaughey’s advice to never look at the scoreboard. That’s how you choke. You just run through. Through the endzone. Into the tunnel. Let’em tell you you scored when you’re gone.

Impatience

I’ll end this section with another personal bit. When I got married we wrote some of the sections of the officiant’s talk. I quoted Louis CK’s “you’re sitting on a chair in the sky” bit from this appearance on Conan in 2009. You cannot outrun the happiness treadmill which manifests as impatience with everything. We thought this message might be a nice one to share with witnesses to 2 people making a life-long commitment to one another.

 

And this more recent clip of comedian Pete Holmes on the Adam Corolla Show…my god, straight into my veins.

It starts with the Waze app. I actually thought it was gonna go in a different direction because my reaction to Waze is also “eat shit” but for different reasons. (I find the app wants me to look at and engage with it while driving far more than I should considering I’m in the most likely situation to destroy mine and others’ lives. You’re asking me whether the speed trap is still there. GFY.)

Your reaction to this video would be a good litmus test for if we’d get along.

 

Moontower #234

Friends,

This letter crossed 13,000 subscribers this week (it averages over 9k views, or similar to the attendance of recently invigorated WNBA games).

I’ve opened and will continue to open the conversation with the greeting “Friends,”. As a pedantic matter, this is offensive to vocabulary. But I don’t scrub into a sterile environment to write this thing. I respond to everyone who emails me so the greeting is inspired by possibility as much as it is a tradition from the sandlot days.

The Sunday letters in particular feel like the stretch of road when you need a break from the radio and figure we may as well chat as if this is not on the test (the test of course being the judgment, no matter how subconscious, that your thoughts are received with).

Today’s confession — there is no “meaning” of life.

It sounds harsh.

But you know what would be even more harsh? Believing that there is one and not knowing what it was. Like you were born into an escape room with a single key to the exit. The clock starts when they cut the cord. You can ask for hints but none of the people who respond through the intercom know anything. You wouldn’t know that based on their confidence of course.

If “why” is so important, I think the best we can do is make our own meaning. Even this feels like alms to a story-hungry mental apparatus adapted for mundane survival needs but is easily hijacked by cosmic inquiry.

You’ve heard of American exceptionalism. Maybe I’m just underwhelmed by human exceptionalism. It would be easy to blame the cosplay of our current political hour but that’s a Budweiser commercial in the longest-running show in history — ‘the cruelty of man’.

I watched Blackfish last month. With only enough emphasis to set the scene, falling far short of its profundity, the narrator described orcas’ communications as indicative of a distributed but coherent consciousness amongst members of a pod. Like a Vulcan mind-meld. Even if this is just a possibility, I cannot shake the sense that humans, rather than occupying a “mandate of heaven” (brb gagging myself with a notebook spiral) are just a parallel timeline written daily through nature’s trial-and-error.

If you’re religious or a “I don’t practice but have faith” or however you self-identify this is not a challenge to you. I wouldn’t dare. I have nothing to add in the face of all the brilliant, earnest, skin-in-the-game individuals or groups who have argued for or against any particular paradigm for our relationship with the unseen. If you feel a certain way you have your reasons. Maybe rooted in logic. Maybe a sensation. They are inviting as matters of discussion not prescription (whether this is a convenient cop-out or pragmatic maturity is left to the reader’s prism).

But to not be called in the direction of such meaning, also rests on reasons. I haven’t felt or seen what you feel or see. And if I’m supposed to seek until I am “found” and thus imbued with meaning, the spirit of such a requirement sounds like an overly specific morning routine. Neither cold plunge nor cathedral holds the key.

Similar to the mysticism of believers, my sensation of “no singular meaning” is mostly a matter of faith not logic.

[There was a phase in my life where I tried to reason to beliefs (as opposed to our default mode where we believe then post-rationalize — an impulse I believe is only resistible in the context narrow, instrumental inquiry). Depending on what you think information is good for, you might agree that being wrong a lot has the useful property of limiting your confidence on edifices built of logic. This is an elementary insight. After all, logic derives from assumptions so there’s always garbage-in, garbage-out risk. It’s easy to understand that on the cerebral level but internalizing that lesson takes practice. Incidentally, a discretionary trading career is one that constantly assaults your epistemology. You think your logical but the chance that you get every link in the chain from idea to trade expression is small (risk management is about unloading intolerable consequences from the inevitable chain failure). Trading hurts. Pain is a useful teacher.]

I say that because I don’t truly understand how I landed on my outlook. I think I’m just unsatisfied with any answer to the meta-question, “how could it have a single meaning?” Or maybe I just haven’t heard enough answers to that question.

I also wonder how other people land on theirs. It would make for a fascinating interview series to ask people what they believe the meaning of life is, or their life specifically…but the most intriguing part would be the answer to “how did you arrive at that belief”?

(If the answer to the “meaning of life” is the biological retort “to procreate” that’s a dead-end in the same way that the answer to “why do you practice freethrows?” leads to “ok fine but [follow-up why]”)

With the personal musing out of the way, here’s an essay that resonated for obvious reasons

The Meaning Of Life Is Absurd (11 min read)
Lawrence Yeo

Excerpts (emphasis mine):

Ironically, knowing that life doesn’t come with a grander meaning allows us to access the things that really do make life meaningful. This truth helps us realize that the big existential questions of life are not where the answers are; instead, this very moment in our small corner of the world is all we really have….

The questions of “What does it all mean?” and “What is my purpose?” are things we ask when we’re not plugged into this very moment. When we’re paying close attention to the project we’re working on, the book we’re enjoying, or the time we’re spending with our loved ones, then we’re not searching for meaning; we already have it….

In this futile pursuit of escaping the absurd, nothing will ever be good enough because we are always chasing an elusive grand narrative, our overarching meaning of life. We will forever be chasing our own tails, wondering when the hell the universe will answer our individual calls for purpose.

From the creator of Rick and Morty, Dan Harmon:

We have this fleeting chance to participate in an illusion called ‘I love my girlfriend’ [and] ‘I love my dog.’ How is that not better?

Knowing the truth, which is that nothing matters, can actually save you in those moments. Once you get through that terrifying threshold of accepting that, then every place is the center of the universe, and every moment is the most important moment, and every thing is the meaning of life.

The theme of “the present” has shown up in the last couple Sunday writings (and while they were just tangential to the main themes they were the lines I noticed were most shared. I don’t know if it’s a sign of our distracted times or an evergreen battle but people are thinking about it.

From The Gasoline of The Internet:

The whole “what you need” discourse is a distraction from the plain truth — there is an “arrival” fallacy at play. It’s very well documented across the board. Win the championship, celebrate one night, then feel letdown. Living in the future (or past) sucks. Never overdose on hope or nostalgia.

I don’t think about a “number” because if you hit it you still have to contend with what you’d do with your time. You should stop pretending that is a problem you acquire when you “arrive”. You have that problem right now.

From Status Symbols:

I’ll tell you what impresses me broadly.

People who look forward to Mondays. People who struggle to sleep because they are so stoked to be awake. This is a person who excels at something they enjoy and has the opportunity to do it. It doesn’t mean their life is free of things they don’t want to do. But their energy is directed towards activities that adequately solve their earthly needs for food and shelter and well-being needs for self-expression & autonomy.

This is messy.

Nobody is “arrived”. You’re always en route.

But it’s the most liberating thought if you let yourself take it seriously.

I love McConaughey’s advice to never look at the scoreboard. That’s how you choke. You just run through. Through the endzone. Into the tunnel. Let’em tell you you scored when you’re gone.

Impatience

I’ll end this section with another personal bit. When I got married we wrote some of the sections of the officiant’s talk. I quoted Louis CK’s “you’re sitting on a chair in the sky” bit from this appearance on Conan in 2009. You cannot outrun the happiness treadmill which manifests as impatience with everything. We thought this message might be a nice one to share with witnesses to 2 people making a life-long commitment to one another.

 

And this more recent clip of comedian Pete Holmes on the Adam Corolla Show…my god, straight into my veins.

It starts with the Waze app. I actually thought it was gonna go in a different direction because my reaction to Waze is also “eat shit” but for different reasons. (I find the app wants me to look at and engage with it while driving far more than I should considering I’m in the most likely situation to destroy mine and others’ lives. You’re asking me whether the speed trap is still there. GFY.)

Your reaction to this video would be a good litmus test for if we’d get along.

 

Money Angle

For today I offer something to read and an open question.

To read

Stocks and Flows (8 min read)
Byrne Hobart

I like this essay because it takes a mor nuanced view of the general admonition against comparing stocks to flows. For example, you shouldn’t compare debt (a stock) to GDP (a flow). But as Byrne says:

They Can’t Be Compared Directly, Except That We Make This Comparison All the Time

Instead of just smacking our hands with a ruler, he goes into why it’s blurrier than a discrete sorting of stock vs flow pretends.

While not central to the essay, I thought the framing in this line (bold) was a nice reminder about how investing works.

Whether capital appreciation is better thought of as reassessing a stock or accumulating a flow is a tough question, which probably comes down to whether the activity that leads to that capital appreciation is repeatable and human-limited, or is not-necessarily-repeatable and capital-limited. For example, making a market is closer to a job than an investment, but buying a passive portfolio is very much an investment—you’re getting paid to deal with volatility and the passage of time, not for any special effort it took you to click the “buy” button.

By the way, that essay is part of Byrne’s free Wednesday series called Capital Gains. I never miss these because they teach evergreen business or investing concepts concisely, but beyond the first level Investopedia treatment.

If you subscribe with this link I could get a mug.

Open questions

This question will probably reveal just how ignorant I am but I’d like to understand.

When I see Stripe being “private for longer”, I wonder are they choosing a higher cost of capital in exchange for control of their investors? If so, what conditions tip the decision towards an IPO?

But, also do I have an incorrect understanding of private vs public? Are private markets so fully priced that there is no risk premia for opacity, accountability, liquidity and Stripe is getting the cheapest capital AND retaining control?

If you know about this stuff let me hear your take.

Money Angle For Masochists

I want to remind readers of the moontower.ai Investment Analysis resource. It’s free to everyone and I keep adding to it based on what I discover or recs from others. I don’t include everything that gets recommended so there’s an element of taste to this. And some of the listings are ones I’m not too familiar with but trust the recommender. YMMV.

I just added these 3 to the list because I personally think they’re good (they’re also all free).

  1. fintechie substack by David Harper

    David is behind the the epic Bionic Turtle YouTube channel. For as long as I can remember he’s been teaching financial modeling.

    I especially enjoyed the recent post: What’s the value of Elon Musk’s stock option pay package?

  2. CBOE’s Derivative Market Intelligence by Mandy Xu

    I just subscribed to this because it’s by Mandy. She was part of our coverage when she was a sell-side vol strategist at CSFB. They would come to our office for an annual presentation and I always found Mandy to be very insightful.

  3. Picture Perfect Portfolios by Nomadic Samuel

    Samuel does in-depth reviews of trend and “permanent portfolio” style ETFs. Super useful content if you are shopping asset allocation products.

     

     

Stay Groovy

☮️

Moontower Weekly Recap

Learn Probability

Dave is a quant at Paradigm. He asked:

https://x.com/_Dave__White_/status/1811557747659538823

The thread is full of recs. I mentioned David Sklansky whose books were assigned reading at SIG 20 years ago. Gambling literature is going to be a great place to search since it will likely balance academic and applied considerations.

To that end I also recommended the OG website —> wizardofodds.com

For decades, they’ve been publishing the combinatorics on casino games and so much more. They even had a list of all the specific video poker machines that had positive edge (yes, there were some. At SIG there was a group that actually exploited this as a fun side extracurricular).

The host of the exceptional gambling podcast Risk of Ruin @halfkelly immediately recommended:

Harry Crane’s First Course In Probability

Others recommended video courses such as:

Statistics 110: Probability by Harvard University

Course in Bayesian Statistics via Virginal Commonwealth University

The Gasoline of the Internet

The internet exposes us to a wide array of perspectives, beliefs, and behaviors that we might not encounter in our immediate, offline environments.

We are outraged by this.

Maybe this is our lizard-brain threat detectors tuned to primitive local survival requirements. An existence where the number of people and places you will encounter in 50 years of life expectancy can be tallied on your fingers. If our ancient white blood cells see modern connectivity as an intruder, our system 2 reasoning can be used to restrain that impulse…”chill sentry, these other ways of being were always there, we just didn’t see them before”.

There’s a particular brand of discourse that recurs constantly on #fintwit’s personal finance channels. It goes like this:

Original poster: “I need this much to retire”

Someone is 100% to be offended and responds:

“No you don’t because [reasons]”

This is a surefire way to farm engagement. It’s a close cousin to NY Times favorite style of finance article “I make $1mm a year and can’t afford life”.

Here’s Ramit, whose personal finance content I usually like, playing the game:

https://x.com/ramit/status/1811075101343039898

Everyone’s entitled to their opinion. I find it difficult to get emotional or even conjure opinions on such a topic. It’s an impotent path of inquiry because it is absolutely crushed by the sheer magnitude of how our perceptions emerge from limitless forking paths of human experience.

I just short-circuit at normative questions of “what should be”. Feels arrogant to get riled up about what others think they need. We change. If you grow up with little and do well, your sights will get set higher. Is this bad? Seems like the wrong question. A misdirection from a more useful framing. And that framing is also a matter of opinion. But that’s one I have a view on.

To invite a personal perspective I’ll admit a simplistic desire. When it comes to what I want to afford, I wanna live in a nice town in CA and not have to count my pennies in the course of a comfortable existence. One in which a special occasion stay at 5 star hotel doesn’t require a separate savings account. But I don’t expect to have a yacht or live-in maid.

At the same time, I don’t pretend we can’t have a lost decade or 2 of returns. It might be low probability but you don’t need to catastrophize to think it’s part of the distribution. Relying on even historical assumptions of investment returns feels uncomfortably fragile to me. Life is a single draw. Relying on non-stationary averages is a building a house like the first 2 little piggies.

[Note: This asset management marketing pitch called “evidence-based investing” offers useful heuristics but if it over-loads your “extrapolate from the past” muscle it’s a Trojan Horse.]

My no-shortcuts belief:

Find the mix of work and expectations that give you a chance of getting to a number with a very high margin of safety which is always going to look like a big number. But you don’t make your happiness contingent on getting there.

My rebuttal to all these “you can get retire on as little as X” is sure you can go live in Egypt too for even less. Maybe I need X because I be living like Y. And it takes a lot of arrogance to yuck people’s Ys. It’s possible they have distorted goggles on but, unless they want help, to assume they are broken feels like a strange position. The American who needs 20mm to retire vs the person who needs 1mm.

Does it really take that much effort to imagine either person without thinking one of them is crazy? You won’t unsee it once I say it — arguing over ranges where reasonable people can disagree is the gasoline of the internet.

The whole “what you need” discourse is a distraction from the plain truth — there is an “arrival” fallacy at play. It’s very well documented across the board. Win the championship, celebrate one night, then feel letdown. Living in the future (or past) sucks. Never overdose on hope or nostalgia.

So that bloke that gets to 15mm and won’t stop “until he gets 25” is probably wrong on thinking there’s an endpoint.* But calling him out for his mentality is judgmental at best and wrong at worst. Maybe that mentality was a prereq to getting to 15 in the first place. Every strength is also a weakness (or so I tell myself when I forget to buy milk because I was daydreaming).

*I don’t think about a “number” because if you hit it you still have to contend with what you’d do with your time. You should stop pretending that is a problem you acquire when you “arrive”. You have that problem right now.

Instead, we can choose grace and not think unusual people need fixing (again unless the person is seeking help). Should posters just write a boilerplate disclaimer: “I realize it’s gauche to say I want 25mm to retire and any reasonable person could retire on less but…”? Do they need to splay themselves on the altar of “be considerate to the average human” before speaking?

There are subgroups of people that, for better or worse, have their own standards for how they want to spend their revolutions around the sun. We could simply choose rules of charitable engagement to assume that default belief instead of compressing variation. When someone posts on r/FatFire they are talking to a selected group of mutuals. You know what’s going to happen when you paste that in the internet’s town square.

My wife and I come from middle to lower class families. Yet, because of our professions have seen a lot of how the other half lives. And we’re part of the other half as our childhood selves would conceive of it. I thought any kid with a GI Joe aircraft carrier was rich. My wife’s “this person must be rich moment” was when she had dinner at a friend’s house and they had Ranch dressing. I only have to drive around my town to know there’s “another half” compared to our current perspective. And to them there’s “another half” flying private everywhere. You get the point.

Not relating to someone else is not news. It’s what should be expected because of how wide the range is. How can something that shouldn’t surprise you, get you fired up? The whole discourse is low-brow projection.

Here’s an experiment to undo this impulse. Consider the Guinness Book. Longest fingernails? Is there any point in trying to relate to someone who goes for that. We don’t try because it’s absurd. The range of humanity is blindingly obvious when you turn those pages.

But when people start talking about money (as opposed to their time, which Guinness people used in wild ways) we somehow think that should be more relatable. Resist that illusion.

You don’t need worry about what everyone wants. These are not matters of right and wrong (vs the boring problem of someone making the equivalent of a counting mistake in describing the how of their money pursuits).

You need $100mm, cool. You wanna live in a van. Right on. For all I hope your expectations are met.

But I don’t think that’s how anything works. Solving for the best way to be useful and happy is a lifelong endeavor. It’s not where you are gonna eventually plant your flag it’s how you carry its weight every day.

It’s true and forgiving to recognize that a lot of people don’t have the luxury of the thought — but what’s much worse is how many don’t have the nerve.

Moontower #233

Friends,

I’ll be short up here because today’s Money Angle got the pen.

This article is b-r-u-t-a-l.

Fast Crimes at Lambda School (39 min read)
Benjamin Sandofsky

It’s also quite embarrassing that one of the first posts I ever wrote on my website could not have aged any worse.

Money Angle

The internet exposes us to a wide array of perspectives, beliefs, and behaviors that we might not encounter in our immediate, offline environments.

We are outraged by this.

Maybe this is our lizard-brain threat detectors tuned to primitive local survival requirements. An existence where the number of people and places you will encounter in 50 years of life expectancy can be tallied on your fingers. If our ancient white blood cells see modern connectivity as an intruder, our system 2 reasoning can be used to restrain that impulse…”chill sentry, these other ways of being were always there, we just didn’t see them before”.

There’s a particular brand of discourse that recurs constantly on #fintwit’s personal finance channels. It goes like this:

Original poster: “I need this much to retire”

Someone is 100% to be offended and responds:

“No you don’t because [reasons]”

This is a surefire way to farm engagement. It’s a close cousin to NY Times favorite style of finance article “I make $1mm a year and can’t afford life”.

Here’s Ramit, whose personal finance content I usually like, playing the game:

https://x.com/ramit/status/1811075101343039898

Everyone’s entitled to their opinion. I find it difficult to get emotional or even conjure opinions on such a topic. It’s an impotent path of inquiry because it is absolutely crushed by the sheer magnitude of how our perceptions emerge from limitless forking paths of human experience.

I just short-circuit at normative questions of “what should be”. Feels arrogant to get riled up about what others think they need. We change. If you grow up with little and do well, your sights will get set higher. Is this bad? Seems like the wrong question. A misdirection from a more useful framing. And that framing is also a matter of opinion. But that’s one I have a view on.

To invite a personal perspective I’ll admit a simplistic desire. When it comes to what I want to afford, I wanna live in a nice town in CA and not have to count my pennies in the course of a comfortable existence. One in which a special occasion stay at 5 star hotel doesn’t require a separate savings account. But I don’t expect to have a yacht or live-in maid.

At the same time, I don’t pretend we can’t have a lost decade or 2 of returns. It might be low probability but you don’t need to catastrophize to think it’s part of the distribution. Relying on even historical assumptions of investment returns feels uncomfortably fragile to me. Life is a single draw. Relying on non-stationary averages is a building a house like the first 2 little piggies.

[Note: This asset management marketing pitch called “evidence-based investing” offers useful heuristics but if it over-loads your “extrapolate from the past” muscle it’s a Trojan Horse.]

My no-shortcuts belief:

Find the mix of work and expectations that give you a chance of getting to a number with a very high margin of safety which is always going to look like a big number. But you don’t make your happiness contingent on getting there.

My rebuttal to all these “you can get retire on as little as X” is sure you can go live in Egypt too for even less. Maybe I need X because I be living like Y. And it takes a lot of arrogance to yuck people’s Ys. It’s possible they have distorted goggles on but, unless they want help, to assume they are broken feels like a strange position. The American who needs 20mm to retire vs the person who needs 1mm.

Does it really take that much effort to imagine either person without thinking one of them is crazy? You won’t unsee it once I say it — arguing over ranges where reasonable people can disagree is the gasoline of the internet.

The whole “what you need” discourse is a distraction from the plain truth — there is an “arrival” fallacy at play. It’s very well documented across the board. Win the championship, celebrate one night, then feel letdown. Living in the future (or past) sucks. Never overdose on hope or nostalgia.

So that bloke that gets to 15mm and won’t stop “until he gets 25” is probably wrong on thinking there’s an endpoint.* But calling him out for his mentality is judgmental at best and wrong at worst. Maybe that mentality was a prereq to getting to 15 in the first place. Every strength is also a weakness (or so I tell myself when I forget to buy milk because I was daydreaming).

*I don’t think about a “number” because if you hit it you still have to contend with what you’d do with your time. You should stop pretending that is a problem you acquire when you “arrive”. You have that problem right now.

Instead, we can choose grace and not think unusual people need fixing (again unless the person is seeking help). Should posters just write a boilerplate disclaimer: “I realize it’s gauche to say I want 25mm to retire and any reasonable person could retire on less but…”? Do they need to splay themselves on the altar of “be considerate to the average human” before speaking?

There are subgroups of people that, for better or worse, have their own standards for how they want to spend their revolutions around the sun. We could simply choose rules of charitable engagement to assume that default belief instead of compressing variation. When someone posts on r/FatFire they are talking to a selected group of mutuals. You know what’s going to happen when you paste that in the internet’s town square.

My wife and I come from middle to lower class families. Yet, because of our professions have seen a lot of how the other half lives. And we’re part of the other half as our childhood selves would conceive of it. I thought any kid with a GI Joe aircraft carrier was rich. My wife’s “this person must be rich moment” was when she had dinner at a friend’s house and they had Ranch dressing. I only have to drive around my town to know there’s “another half” compared to our current perspective. And to them there’s “another half” flying private everywhere. You get the point.

Not relating to someone else is not news. It’s what should be expected because of how wide the range is. How can something that shouldn’t surprise you, get you fired up? The whole discourse is low-brow projection.

Here’s an experiment to undo this impulse. Consider the Guinness Book. Longest fingernails? Is there any point in trying to relate to someone who goes for that. We don’t try because it’s absurd. The range of humanity is blindingly obvious when you turn those pages.

But when people start talking about money (as opposed to their time, which Guinness people used in wild ways) we somehow think that should be more relatable. Resist that illusion.

You don’t need worry about what everyone wants. These are not matters of right and wrong (vs the boring problem of someone making the equivalent of a counting mistake in describing the how of their money pursuits).

You need $100mm, cool. You wanna live in a van. Right on. For all I hope your expectations are met.

But I don’t think that’s how anything works. Solving for the best way to be useful and happy is a lifelong endeavor. It’s not where you are gonna eventually plant your flag it’s how you carry its weight every day.

It’s true and forgiving to recognize that a lot of people don’t have the luxury of the thought — but what’s much worse is how many don’t have the nerve.

Money Angle For Masochists

Dave is a quant at Paradigm. He asked:

https://x.com/_Dave__White_/status/1811557747659538823

The thread is full of recs. I mentioned David Sklansky whose books were assigned reading at SIG 20 years ago. Gambling literature is going to be a great place to search since it will likely balance academic and applied considerations.

To that end I also recommended the OG website —> wizardofodds.com

For decades, they’ve been publishing the combinatorics on casino games and so much more. They even had a list of all the specific video poker machines that had positive edge (yes, there were some. At SIG there was a group that actually exploited this as a fun side extracurricular).

The host of the exceptional gambling podcast Risk of Ruin @halfkelly immediately recommended:

Harry Crane’s First Course In Probability

Others recommended video courses such as:

Statistics 110: Probability by Harvard University

Course in Bayesian Statistics via Virginal Commonwealth University

Fun

This isn’t probability but I came across this question on Twitter (answer at the end of the post. My answer anyway. Hopefully it’s the right one but I never saw the solution):

 

From My Actual Life

I turned 46 on Friday. The thought I tweeted:

21 years ago today @BrendaDellaCasa introduced me to this wife & life at my surprise bday party at Climate 8 in NYC. Forever in debt.

Image

My lovely wife informed me tonight we’ll be seeing Nate Bargatze in Vegas on our 15 year anniversary. I actually haven’t been to Vegas since covid but used to get there every year at least once since moving to CA in 2012.

Anyway, thanks for all the shouts today…I’ll say I didn’t care about birthdays when I was younger but they are days I remember now and just not taken for granted.

I had a bit of a scare 2 years ago on my bday and went to the ER in the middle of the night with my heart not feeling right. Just a fluke but gave up drinking the next day for health reasons (I have sake every few months and I have a standing rule to have a drink if I find myself in a tiki bar)

Anyway, I feel grateful and motivated, and as a matter of being on your timeline — flattered that I would have people follow/read my shit.

Keep going.

Stay Groovy

☮️

Solution to the Barclays question

I solved this in 2 ways. Both start with the basic observation that the pond will be covered by 2³⁰ lilypads

  1. The first way I saw this problem was that starting with 8 lilypads is equivalent to starting with one but on the 3rd day. So instead of taking 30 days to fill the pond, you will need just 27 days.
  2. The second way to see the problem is by noticing that each starting lilypad will contribute 1/8 of the full coverage.

    What’s 2³⁰ / 8?

    2³⁰ / 8 = 2³⁰ / 2³ = 2⁽³⁰⁻³⁾ = 2²⁷

    Again, 27 days.

Ratio’d

Last week in Breakpoints, the discussion was about measuring implied skew.

A common measure and the one we use in moontower.ai is normalized skew which computes the percent premium or discount of IV at the 25d strike vs the 50d strike.

It’s not a measure that lends itself to direct interpretation. If 50d IV is 30% and the 25d put is 36% that’s a normalized skew of 20%. It doesn’t mean anything on its own but it is useful to see if skew is relatively or historically high or low. You chart it as a time series or percentile the value on a 1 or 2 year lookback. You can compare skew cross-sectionally across correlated assets.

Skew, or any measure, can be attacked from any number of angles. Our single measure of normalized skew itself requires choosing tradeoffs. The last post addressed the biases of various breakpoints. Moneyness, standard deviation, and delta-relative are all common ways to fix the gridpoints.

Today, we’ll use an approach that many might find more intuitive — thinking about skew in terms of option premiums instead of implied vol. When we look at option chains we are looking at prices. When we trade options our p/l depends on how the premiums change. For many investors, premiums are a more natural way to think about options than IV.

We will use GME to demonstrate a number of ways to think about skew which are more tightly intertwined with how skew trades are expressed — through verticals and ratio’d verticals.

We can even turn the metrics into a simple oscillator based on arbitrage bounds. If I do my job right, this post will make the concept of skew more concrete and inspire you to track it in new ways.

I started this GME case on a data exploration lark. Baycrest option strategist David Boole said that the call skew on the latest rally surpassed even the 2021 craziness. I wanted to look myself but I didn’t want to just look at normalized skew by delta.

Because I knew the call skew was so fat I was a bit uneasy about the recursive nature of delta-relative gridpoints. The last post uses a concrete example to demonstrate how option vanna causes the delta of an option to change with the IV which muddies the answer to “what did skew do today?”. Truthfully, this is a nerdsnipe for non-vol traders, but as a vol trader it’s bothersome enough that I wanted to choose a different tradeoff.

I opted for a standard-deviation relative surface for the study instead.

Let’s step through it.

1) Pull end-of-day GME data from 1/4/21 to 6/14/24

In particular:

  • .50 delta IV for the option closest to 30 day expiry (range of actual expiry dates in ranged from 27 to 32 DTE)
  • The breakpoints that correspond to 1 and 2 standard deviation OTM upside strikes estimated using .50 delta IV and actual DTE.
  • Call premiums at the closest strike to the breakpoint subject to some error tolerance (ie the strike needs to be within 10% of the breakpoint IV but that 10% is scaled to IV. If IV is only 30% than a 10% divergence from strike to breakpoint is not acceptable but if IV is 250% than it’s ok). If no such strikes were listed the day is omitted.
  • The vega of each option. I also estimate the vega of the theoretical ATM call using the approximation .4*S√t
  • Call premiums are normalized by measuring them as a percentage of the stock price.

2) Chart the 1 and 2 std dev OTM call premiums as % of stock price.

The .50 delta IV is on the left-axis. We can see the recent spike relative to the early 2021 spike. We can also see how the 1 and 2 st dev OTM calls explode in value.

But we expect option prices to rip when vol explodes.

Skew is an attempt to say something about how the relative value between options of the same expiry change. So far there’s is no notion of skew.

That sounds like a job for tracking a vertical spread as percentage of the stock price.

3) Chart the 1 SD / 2 SD call spread.

Hmm…this feels unsatisfying. The call spread is also spiking with the call values. We’re not learning much from displaying the spread.

There’s a good reason for that.

These call spreads, like outright calls have positive vega. As vol increases, OTM call spreads increase in value.

Instead let’s look at the 1×2 ratio call spread.

4) Chart the 1 SD / 2 SD ratio call spread (2 further OTM calls vs a single 1 SD call)

Ahh, now we are seeing the value of the 1×2 decline on spikes in vol. In other words, a structure that is long 1 OTM option and short 2 further OTM options is losing value when vol roofs. It’s hard to say what’s driving this however.

As IV increases, OTM options gain vega. Not only do the options go up in value, but they become more sensitive to IV. This is vol convexity. Every uptick in IV increases the option value more than the prior uptick. Like your position is growing! This is the “gamma of vol” or vol convexity.

At an extremely high level of vol, all OTM options approach .50 delta. The vega of options of different strikes will converge.

Assuming you own the lower strike and short 2 further OTM strikes, the 1×2 starts as a long vega trade from low levels of volatility. But it is short vol convexity or “gamma of vol”. At crazy high vols, the vegas converge and your net greeks converge to the net amount of options in your position — in this case you are net short 1 option. Your position vega, or sensitivity to IV, is now negative. So as vol spikes, the 1×2 loses value.

(Another way to think of this is that a 1×2 is equivalent to being long 1 call spread plus being short an extra option. At high enough vols the call spread’s net vega is a wash and you are just short an option.)

The picture above makes it hard to disentangle skew changes (ie the relationship between the 1 and 2 SD strikes). It is confounded by the changing vega of the structure.

Let’s back up and simplify for a moment.

We can compare the ATM call with the 1 SD OTM call so we aren’t trying to parse skew changes across 2 OTM options. And we’re going to control for vega itself!

5)The vega-neutral call spread

Instead of fixing a ratio such a 1×2. we will stipulate that our call spread must be vega-neutral. To do that we simply solve for the ratio that makes the vega of structure zero. In other words, we count how many OTM calls we need to short, for each ATM we are long.

The fewer options we need to short, the steeper the skew must be! In an infinite vol situation, all calls go to their maximum value — the stock price itself. Which means the call spread is worth zero (since all the calls are the same price) and each call has the same vega (which is weirdly zero — at infinite vol, changing vol by one point isn’t going to change the option value).

I like using extremes because they establish arbitrage endpoints from which to reason backwards from. In a high but not infinite vol situation, the ATM and OTM calls will not be equal. But perhaps the ATM call vega is just a bit higher than the OTM call. In that world, you only have to sell slightly more than 1 OTM call to be vega-neutral.

Repeating — the lower the ratio of the vega-neutral spread, the steeper the skew.

Here’s the chart.

Remember, this is a vega-neutral ATM/ 1 SD call spread. In the recent spike, the OTM calls were so jacked compared to the ATM that selling 11 calls for every 10 you bought would have been vega-neutral!

Let’s reproduce the chart but shifting the strikes to 1 SD vs 2 SD.

The picture is similar but the ratio to make the spread vega-neutral is more volatile. (That 2 sd call is also noisier because when the premium is only say 1% of the stock price, slightly leaned or errant marks matter more.)

Extra: A 1×2 indicator

By tracking the ratio of further OTM options needed to make a spread vega-neutral is an alternative way to track skew. Like normalized skew it reduces vol artifacts but because it maps to option premium as a percent of the stock price it feels more interpretable. “Wow, the skew is so high I can sell 50% less options to finance the same long premium” or “I can own 3 OTM calls for the price of 1 ATM”

In practice, the option markets tend to coalesce around some common structures. The 1×2 vertical spread is an easy to ratio to keep in mind. It becomes like a tool in the trader quiver…they might look at a surface with low or high skew and gravitate to “how’s the 1×2?”

If we fix the ratio as 1×2, accepting how its shorthand does conflate vol and skew effects a bit, we can create an indicator that has the same shape but lives on an oscillator — it’s bounded by 0 and 1.

To do that think of the extremes.

a) The most a 1×2 ratio call spread can be worth (from the perspective of owning the 1 and shorting a ratio of the further OTM) is the premium of the 1.

Example:

A stock is $50 and the 1 sd strike is $55 and the 2 sd strike is $59. If the 55 call is worth something and the 59 call is worthless, then the ratio is simply the value of the 55 call.

b) The least a 1×2 ratio call spread can be worth is the -(the premium of the 1)

Example:

Vol is outrageously high. There is little difference in premium between OTM strikes. In other words, the call spreads are worth very little. Much like GME recently where the 55 and 60 strikes were almost the same value. We’ll be dramatic and say both calls are worth $1. The 1×2 is worth -$1. If you buy the 55 call and sell 2 60 calls, you’ll collect a $1 credit. The credit cannot be larger than this since the 55 call cannot be worth less than the 60 call.

With an upper and lower bound on the value of the ratio we can simply compute the value of the 1×2 in relationship to its range.

Here’s a time series of the GME 1×2 oscillator:

Wrapping up

The point of this post was to provide more angles to rotate the idea of skew in your head. In the process, I hope I was able to convey how implied volatility influences option prices both absolutely and relatively.

As GME goes, the skew does in fact look like it climbed higher than it did in 2021. It’s most noticeable in the simple ATM/ 1 SD vega-neutral spread.

But the peak of the skew, wasn’t that much higher than the peak in 2021 suggesting the market adapted pretty quickly the first time around. After all, option market makers presumably learned “total nonsense is possible”. They had the benefit of the 2021 experience to draw from in setting curves and didn’t push it them too much further than they did back then.

The craziest event is always in the future, but it’s not unreasonable to reference the GME case as a point of comparison the next time skew explodes in a name and you are wondering “how ridiculous is this situation compared to the Roaring Kitty meme sheets?”

Food for thought

About 20 years ago, as a still junior option trader, I interviewed for an options trading role at a fund chaired by Myron Scholes. They were called Platinum Grove iirc. LTCM lineage. I wasn’t smart enough to work there. A fortuitous miss because I think they got blown out in 2008. I don’t know for sure so don’t quote me. (I can speak more freely in the paid letters but I don’t want to offend or misrepresent unfairly either. This is just what I remember and I didn’t care enough to verify.)

Anyway, one of the pre-screen questions was how can you construct a market-neutral long vol convexity position?

The answer they were looking for was a ratio iron fly. Assuming a “typical” vol surface, you can buy about 1.4 25d strangles for each ATM straddle you sell. The position will be flat vega but:

a) as IV falls you get shorter vol

Think of the extreme where IV falls to something like 5%. The strangle you own is worthless and you are short a straddle. Your vega is short. As IV falls, your vega falls. You are long “vol gamma”.

b) as IV increases you get longer vol

The straddle goes up in price but it doesn’t gain vega. ATM (technically ATF) straddles are already at maximum vega! But the strangles you are long, gain vega so as vol increases they start gaining value at a faster pace than the short straddles hurt you.

A ratio iron fly is equivalent to a ratio call spread + a ratio put spread. If you widen the strikes from 25d to say 10 delta maybe it’s a 1×2 call spread + 1×2 put spread. By tracking the prices of specific structures normalized to the stock price you can get a sense for how the vol surface is behaving without knowing the IV on the strikes themselves.

You will still some concept of vol to measure the distance of strikes from one another whether it’s delta or standard deviation.

You can also fix the price of structures and invert the questions — “how far apart are the strikes I need to construct a zero-cost collar” or “how far apart are the strikes that make the 1×3 costless”? Then the distances become values you can track in your analytics.

The more you can apply a familiar lens to various opportunities the more you can build a mental pattern-matching library for what looks “off”.

It might sound salesy but this very much why the moontower.ai approach is so dear to me. Once I left the desk, I felt blind because I was so accustomed to seeing markets from a lens that efficiently filtered what’s normal from abnormal amidst all the noise. As a discretionary trader, it was the ladder to the diving board. There were still steps to take before you jumped but most of the effort was handled in the canned measures.

moontower.ai is building to recover my sight. In the process, we can give other option users the same vision regardless of what their objectives are.

Breakpoints

I caught David Boole’s segment about GME on CNBC because it was on Twitter. David used to cover me back when I showered every day. I agree with all of the framing.

He mentioned that the call skew in GME was higher this time around then back in early 2021. This made me want to look up the data but also prompted me to measure skew differently. But the “how to measure implied skew” question was a ball bouncing in my head already.

After publishing Scatterplot Gallery, Dave (not David Boole but an options market-maker) responded:

Dave is right. Sell side research likes normalized skew as a measure. So do I. We use it in moontower.ai. It’s how I looked at skew during my days at the fund and it’s the parameter I used at the spline points for my vol surfaces. I built up an intuition for those ratios over time per name. It’s also easy to compute.

Normalized skew is simple ratio of the volatility at an out-of-the-money point on the curve to the at-the-money volatility. It is common to measure at skew at the 25 and 10 delta strikes both on the upside and downside of the volatility surface and use the 50 delta option to normalize. (note the 50d strike is often but not always the at-the-money strike).

For example, assume:

Strike: 50 delta, IV: 28%

Strike: 25 delta put, IV: 32%

Normalized skew = OTM volatility/ ATM volatility – 1

Normalized skew = 32%/28% – 1 = 14.3%

The 25d put is trading at a 14% premium to the ATM volatility.

But…

Dave is CORRECT.

The measure doesn’t really make sense. It’s useful because it normalizes skew to ATM vol, but the measure often has a non-linear relationship itself to the vol. OTM options are sticky at the extremes of vol — so normalized skew flattens when vol gets high and steepens when it gets very low. So if you wanted to know if skew is “high” or “low” you still might want to condition it on vol level. Which of course, negates some of the benefit of normalizing it in the first place.

In general, it’s safe to use because it will correlate strongly with alternative measures of skew — it still captures “high” or “low”.

But unless you are a vol trader accustomed to how that parameter maps to prices because you see it in a model every day next to option premiums, it’s abstract.

Measuring surface and skew changes is a big topic in setting vol surfaces (or sheets if you’re “book a colonoscopy years old”).

Today, we’ll discuss skew models which will serve as background for next week’s paid post where we:

  • look at another measure of skew in the spirit of Dave’s comment
  • apply it to GME and David Boole’s comment

For both posts, we will be visual and lean towards simple.

Skew Models

Skew models allow traders to parameterize a vol surface. In other words, fit an IV curve to a discrete chain of strikes. From cubic splines to the vanna-vega-volga model, you can gorge yourself on as much complexity as you want.

Us knuckle-draggers who think an ecole is something you get from bad burger meat are just going to throw a line through some points. This is an example from the famous TT software:

Vol Curve Manager overview | Vol Curve Manager Help and Tutorials

The vol curve requires:

ATM or ATF VOLATILITY

Implying an ATM vol from the market or setting your own:

BREAKPOINTS

Finding the IV of the strike at various moneyness, SD’s(standard deviation points) or deltas. Any of these measures is an attempt to measure the distance from the ATM strike to the “breakpoint” (ie 25 delta or 1 SD). Careful, moneyness is not a normalized measure. If a strike is 5% OTM, it’s much further away in a 10% vol name than a 50% vol name.

Example

The pictured model has 3 SD points above the ATM strike and below the ATM strike. Beyond 3 SD’s there will typically be a linear slope coefficient that fits the tails. That IV can then be parameterized by its ratio or spread to the ATM vol. So if the 25d put is 33% and the ATM put is 30% we are running a 25d put skew of 3 vol points or a ratio of 110%. As we’ll see, there’s no right way, just trade-offs.

Comments

  • The goal is fit the market snugly but without creating arbitrages in the option premiums due to weird kinks. These curves interpolate vols for the strikes in between the breakpoints. Market makers play whack-a-mole with kinks that get out of line.
  • Deal stocks or other assets with idiosyncratic behavior around specific price levels (think of how coal-switching puts a floor on nat gas prices) usually don’t have bell-shaped distributions. It’s hard to fit curves to them. Wrong tool for the job. That’s what Excel and some common sense is for.
  • As mentioned earlier moontower.ai uses normalized skew by delta

On modeling skew changes

  • “Sticky strike” refers to a model that assumes strike vols (vols at specific dollar strikes) stay fixed. This is reasonable over short horizons or smaller moves. It’s unlikely to hold over the time frame in which an OTM 30 strike put becomes far ITM
  • “Sticky delta” means we expect IVs at various deltas to maintain a stable relationship with the ATM volatility. This is an implicit assumption if you use normalized skew — “I see that the 25d put seems to persistently trade at 110 to 115% of ATM vol”

There are hybrids and permutations. In a professional setting, that gamut ranges from highly bespoke proprietary models to a wide array of vendor software. I’ve used many types of models. Spot-vol correlation parameters were much more widely used in my second decade of trading. I’ve even used flat sheets, no skew at all. I’d just have a mental log of how far from flat sheets options of a particular distance from ATM would trade. I’ve used models that don’t have vols — everything is handled in price space. The models themselves were never a source of edge. But if a scale is consistently adding 2 pounds it’s still useful for comparison as long as you weigh everything with that scale.

This is why normalized skew is fine for cross-sectional comparison. It answers the question you’re interested in even if it’s hard to interpret on its own. The truth is measuring skew is like trying to pinpoint a firefly from its sporadic bursts of light.

Consider a made-up $20 stock with a 6-month IV of 40%. I fit a dumb skew model to it (it’s an Easter egg for a certain group of people, all of whom likely have reading glasses by now).

Things to notice:

1) Standard deviations are computed using 40% ATM vol. Those computations are explained in Using Log Returns And Volatility To Normalize Strike Distances.

2) Let’s look at the $24.50 strike. We can describe that strike in many ways:

  • 22.5% OTM (moneyness breakpoint)
  • .25 delta (delta relative breakpoint)
  • .72 SD’s OTM (standard deviation breakpoint)

3) We can describe its skew:

  • 3.9% clicks below ATM vol (spread relative)
  • 9.8% discount to ATM vol (ratio relative aka normalized skew)

Like good little option taxonomists we can say lots of little things about our friend the $24.50 strike.

But now we shall kill him.

Some hedge fund wiseguy with an S&M fetish puts on a giant collar — buys puts and sells calls. Ravages the skew.

The ATM vol stays the same, the collar is vega-neutral. But we’ll assume the 24.50 call’s fixed strike vol drops from 36.1% to 32.3%, nearly 4 full clicks.

What can we say about this option?

  • Well, it’s still 22.5% OTM.
  • It’s still .72 standard deviations away since the ATM vol hasn’t changed (assume it happened quickly, so not much time elapsed).

The normalized skew has changed. The strike now trades at a 19.3% discount to the ATM vol (32.3/40 – 1).

That’s important. It tells us our measure is working — the call got hammered relative to the ATM and the discount got wider. Basic counting still works.

But we have a small problem.

If we parameterize our surface by delta we have a “nail Jell-O to the wall problem”. By virtue of the vol coming in, the delta at the strike also falls (this is also known as “vanna” — the Commander-in-Chief of greeks — getting both too much credit, blame, and airtime relative to its efforts).

The $24 strike is now the .25 delta call. Its vol is 32.9%. If you are looking at skew changes using delta relative parameterization you will see skew fall from -9.8% to -17.8%. A steep drop but not quite the drop to -19.3% change if you used standard deviation relative or fixed strike relative breakpoints.

Summary:

 

Pictures are always better for these things:

The nuances of tracking skew changes are to finance what Equus Erotica is to sex. Like 40 people care.

Other sources

I’m not at liberty to blast it out but this was a widely-read piece on measuring skew:

You can also see Colin Bennett’s free book. My notes are here.

Just remember…

  • The delta relative breakpoints are recursive in that the strike vols changing alters the strike deltas.
  • SD relative breakpoints slide around with the ATM vol and time passing.
  • Moneyness breakpoints jump around with every tick in the stock.

Whatever you pick, just be consistent and understand its biases. And when I say “you” I mean pros. If you are anyone else losing sleep over this, you’ve lost the script.

Options stuff is fun, “bicycle-for-the-mind” and all that. Just don’t think you need to know this. There’s no money printer at the end of this rainbow. It’s mostly useful for managing the risk of large option portfolios — the less stuff you trade the more irrelevant this stuff is.

You’ll go far in life if you can just be good enough to remember your hole cards and not need to check’em again to see if 3-7 offsuit is playable.

Narrating An Option Trade

I’ve been narrating my small GME trade this week through this substack and twitter.

On Friday I rolled my short June 20 calls to the 25 strike. I narrated my thinking on twitter but I’ll re-print it here. It’s a combination of real-time thinking and some meta-thoughts about trading as well.

Sharing my monkey thoughts as i mess around in GME… I’m long that 20 lot of June 20/30 call.

Rolling the position

Despite the stock being down today, the 30s are eroding as vol is declining so the spread actually upticked in value.

I’m also looking at the june 20/25 call spread:

From my IB montage

The spread value has increased a lot. The vega on these options is small but not totally negligible. Look at the IV spread…it’s fallen 14 points today on a spread with a penny of vega – that’s a 14c rally in the spread on a delta deutral basis! Since the spread is only .23 delta, the vol change has kept the spread little changed despite the stock move.

I decided to roll my short 20s into short 25s.

So I sold the June 20/25 cs. I was filled at $3.71

I was long the June 20/30 cs from $2.08 but collected $3.71 on the 25/30 cs.

=> On balance, I’m left long the 25/30 cs for a $1.63 credit.

 

Thinking behind the roll

The roll was driven by a sense that the risk-reward on the 20/25 cs at $3.71 is not as great as owning the 25/30 for a m-t-m level of $1.60.

I’m synthetically “selling the 20/25/30 fly” in my reasoning.

This is a mix of seeing the strike vol changes today and feel. This may sound woo woo. If you require higher standards of trade discretion I can understand that but for the most part this is kinda what trading looks like for all the nerdom that gets bandied about.

GME is a name that doesn’t lend itself to data analysis or cross-sectional triangulation.

[Also, these are microscopic stakes —the original trade only risked about $4,200 and was only 1/5 of the size I wanted to scale into. Unfortunately, the call spread went straight up in value after I was filled and I was too anchored to chase]

In a professional setting, you will be more plugged into flow which tightens the reasoning and timing plus better execution tools/costs, but the mental progressions of a MM very much rhyme with mine especially in idio situations.

The value of tracking

After selling the 25/30 call spread, I stored it in my watchlist on a delta-neutral basis vs the stock price reference I sold it against to track its performance and my fill quality.

The market on a delta-neutral basis is $3.52-$3.89, I sold at $3.71.

June 20/25 call spread

I noticed as the stock went down my fill marked better and vice versa.

This can be an artifact of market widths in the legs esp since both calls are ITM but if you can rule that out by tracking the counterpart put spread instead (CS + PS = Box so you can translate the 3.71 cs as a 1.29 PS) you can get a fingertip feel for how the skew moves as the stock changes by watching a delta neutral price move. I used to do this for lots of structures. They’d be in my window for weeks so I can see how certain large trades worked or not.

Experience is a repo of unstructured data

Overall, these little habits accumulate as a big unstructured data repo otherwise known as experience. Discretionary trading uses “science” for measuring. models, dashboards, stat studies. But the trading is a boardgame sitting on top of that.

Systematizing

Systematic trading is different. I sat next to people running large systematic strategies. It’s piloting & auto-piloting a more diversified strategy, less chunky risk but it’s not an alien approach. It’s also inspirational because you can port measures and ideas from it

I never really figured out how to systematize my trading from end to end. I like to say discretionary trading is just trading without ignoring unstructured data. The unavoidable pitfall is part of that “unstructured data” is bias however.

You can fight that with a team of people conscious of behavioral biases because while it’s hard to debug yourself it’s easy to call out others’ blindspots. You can help each other. (see Trading Is A Team Sport)

moontower.ai

It’s funny as I’m sandboxing analytics to develop for moontower.ai, I’m always thinking about how to pre-chew ideas for users.

There’s always a balance between legibility and user effort. If investors just hand you money to manage for them, it requires no effort for them but they have no control over the trades or process.

At the other extreme, you can give a user a Bloomberg terminal where they have full control but need to make all the decisions.

For a retail user this trade-off requires tremendous thought. You could just feed someone a signal without teaching them how to fish. When the signals don’t work they’ll churn. Or you can teach them how to approach their goals methodically understanding that there’s a learning curve. It takes more effort for the user but for the person who wants to learn to fish it’s the only way.

moontower.ai balances being opinionated but not signal-driven because it inherits the exact trade prospecting funnels I used as a discretionary PM.

We can see the seeds of signals in our “axe list” concept. It’s just a roadmap idea at this point. But some of the data play I’m doing for this coming week’s paid post looks like it might be a source for another analytic regarding skew.

As a reminder, if you’d like to signup for moontower.ai as a paid user, a moontower.substack paid sub is included.

We also have a fully automated affiliate program. If your audience would be interested in option analytics with a point of view…you can sign up to be an affiliate and get $100 for users who sign up.

$ Become A moontower affiliate

 

Arb in ADBE options? (twitter thread)

A Twitter friend thought he might have found an arb in the ADBE options that could be exploited by a trade known as a ‘conversion’. It was a false alarm but if you scroll through the thread you can learn a lot about computing implied rates and the details of how to execute the conversion arbitrages. They don’t sit around in plain sight but this is the masochism section so if you want to learn the thread is a real-life process of noticing something that looks off, getting to the bottom of it, and learning a lot about options in the process.

Status Symbols

This tweet rubbed me the wrong way.

No shade to the author. He’s just making an observation. I have no bone to pick with its truth value. The tweet bugs me because it is a poignant reminder of how easily we are manipulated.

A few comments on status generally.

  • There’s a lot of discourse about status games, luxury beliefs, status legibility, and even status-as-a-service.
  • Status is scope dependent. Every subculture from gamers, to social justice warriors, to Yakuza, to Maori tribes has its own status hierarchy. You might be a lowly admin at work but be the greenest thumb in your gardening group.
  • Status liquidity varies. Airlines are never going to invite current and past Grand Wizards of the KKK to board with the active military. Meanwhile being rich/famous appears to give your words more weight even if your source of status has nothing to do with your thoughts being worth a spoon of sand. (I think one of my favorite discoveries in the world of permissionless posting is watching wildly successful people accidentally reveal how little intelligence has to do with making money — since brains like height aren’t evenly distributed this is a delightfully egalitarian conclusion. If you’re keeping score, the flipside should also get a point — smart doesn’t equal effective.)

Reality is in the room with us — status games are unavoidable. We are social creatures who use status to compress information. But the tweet bugs me because it reminds us that the speed of heuristics has a cost. In the same way tests narrow the definition of learning in the name of scalability, the tantalizing aroma of status cheese lures us from fuller definitions of growth.

Status is a zero-sum game. If money or abs are prestigious but we all get richer or take ozempic then status transfers from achieving objectively desirable ends of wealth and health to having these things more efficiently — can you be rich while also wearing flip-flops? If you have abs but work out 4 hours a day for them then your status goes through the other side of the Pac-Man map to “Jersey Shore reality star”.

The tweet is a reminder that status symbols change. It’s fashion. The symbols go in and out of style. If you orient your heading to those goals by definition you will fall behind the curve. If everyone is fashionable, nobody is.

You’d have to be a real piece of bread to read this and be like “oh my god I need to stop chasing these status markers”. Status-seeking to the point of self-detriment is more insidious. It takes the form of copying which we were built to do. Approval-seeking monkeys hacked by social proof. In the age of “you need 12.5 min of sunlight right when you wake up, followed by a 59 mg titer of nootropics…” you are playing adult Pokemon Go where the goals are set by people who believe in 3-figure probabilities. (Hey, sometimes the mask slips and you see the structure of the game.)

I’m not above status games either. Nobody is. But I don’t see any specific thing like a “meeting-free calendar” and think this person is “free”, “absolved”, or “in-control”. Because I have no idea what that feeling means to them. Anyone who thinks otherwise is projecting what they think it would mean to them. I’m unprepared to draw conclusions from such observations.

I’ll tell you what impresses me broadly.

People who look forward to Mondays. People who struggle to sleep because they are so stoked to be awake. This is a person who excels at something they enjoy and has the opportunity to do it. It doesn’t mean their life is free of things they don’t want to do. But their energy is directed towards activities that adequately solve their earthly needs for food and shelter and well-being needs for self-expression & autonomy.

This is messy.

Nobody is “arrived”. You’re always en route.

But it’s the most liberating thought if you let yourself take it seriously.

I love McCaughnney’s advice to never look at the scoreboard. That’s how you choke. You just run through. Through the endzone. Into the tunnel. Let’em tell you you scored when you’re gone.

Persist, ignore the crowd (but not the opinion of those you deliberately accommodate — this list should be small — you cannot serve everyone), and realize that course-correction is a constant.

The original tweet is irksome because the list unjustly narrows the imagination in a way that obscures the broader spirit — intentionality choosing your compromises. To many, the ultimate status is not having to make compromises. This is a childish view. Life is risk. In ventures and relationships. Risk is vulnerability and vulnerability means compromise. Being able to choose your compromises is a more reasonable asymptote to strive for.

All of this thus far is me engaging the tweet at its face.

But I have a red pill reaction too.

The tweet is a clue to the illegitimate foundation of status — the projection of desire that intersects with evolutionary fitness. We are obsessed with images, youth, and vitality but we live well past reproductive age.

Which makes the most underrated form of status — grace. Navigating our common compromises with courage and integrity instead of fantasizing about controlling them. (I said “underrated”, but “unrated” closer to the truth.)

Look around at who has status. How many of them do you think have honor? Too often we confer status by standards that are bankrupt. Just like a test we are taught to.