As I researched the structure of the human brain to prepare for this two-part series on anxiety disorders, it became strikingly clear to me why this struggle exists. It’s built right into the anatomy our brains.
Robert Sapolsky, professor of biology and neuroscience at Stanford, sums up the entire role of the frontal cortex quite nicely: “the frontal cortex makes you do the harder thing when it’s the right thing to do.” It’s no surprise that it’s the most recently evolved brain region in humans, but is not fully formed in our primate cousins. Interestingly enough, the frontal cortex is the last part of the brain to fully mature and go online – this doesn’t happen until our mid-twenties, which explains a lot of the stupid shit we did in our younger days.
since the connecting pathway to the PFC is literally longer, the amygdala gets thalamic input first.
Whenever you’re in a fearful situation with high emotional arousal (“I’m scared I will die of a plane crash!”) and you’re able to use a cognitive response to calm it down (“The odds of dying in a plane crash are MUCH lower than if I were to get into a car, so it doesn’t make sense to feel this dread”), that’s the ACG allowing you to make that shift between emotion and cognition. The ACG is really important in the gradual unlearning of fear in anxiety disorders, and one of the keys to a healthy ACG is the neurotransmitter serotonin. the simplest way to think about serotonin is to equate it with regulation. It allows for smooth functioning of the anterior cingulate gyrus. The thing about the ACG is that if left unregulated, it has the tendency to spin around wildly, When this happens, emotionally-charged thoughts get caught in this constant loop …This is a prominent feature of people with Generalized Anxiety Disorder, where intense and destructive worry can result from unreasonable thoughts. For example, let’s say you were at work and you emailed a document to your boss that contained a minor error. The reasonable response would be to simply dismiss that error as a minor one and go about your day. However, for someone with intense generalized anxiety, he could think that the error would be a sign of his gross incompetence, leading his boss to fire him, leaving him without a means to support his family, which will ultimately end in destitution and eventual homelessness. As implausible as this sounds, this negative thought can continue to loop around and grow, causing deeply unpleasant cycles of worry and fear that just won’t go away.
A healthy level of serotonin in the brain is crucial, and one reliable way to boost it naturally is through consistent exercise…However, just telling Sam to exercise more often is some pretty generic, unhelpful advice. Chances are that if you’re some form of human being, exercise is a good thing for you. Telling an anxiety-ridden person that exercise will make him feel better is just as helpful as telling a college student that studying will be a reliable way to get good grades.
What can I do to feel less anxious in way that lasts?
His cognitive error constructed the false belief that people always found him boring. Correcting these cognitive errors allows for healthier and more realistic beliefs to take their place. This is the core thesis of cognitive behavioral therapy (abbreviated as “CBT”), which places false beliefs as the origin point for the emotional states of fear and anxiety. According to Aaron Beck, the founder of CBT, if these false beliefs can be properly identified and replaced, then the associated physiological sensations can change, and healthy behavioral shifts can follow accordingly.
CBT requires consistent, rigorous communication between the therapist and patient, and its efficacy relies upon the client’s ability to accurately self-report his situation.This is what is known as an explicit form of treatment, in which the client uses his conscious awareness and verbal reporting of emotional experiences to reappraise and change them. The client will have to consciously use working memory to identify false beliefs, replace them, and report these shifts (both to himself and to the therapist) as he’s making them. Since executive control and conscious processing are the working gears of explicit methods, the area of our brain that is targeted with CBT is that magical sage of ours: the prefrontal cortex (PFC).
What about the nonconscious processes that act as the origin points of fear and anxiety? Those uncomfortable physiological sensations like chest tension, sweating, flushing, etc. that happen before we are aware of them? Or the bombarding of thoughts that happen automatically once a stranger approaches us? What can we do to decrease the likelihood of these automatic reactions from arising in the first place? For that, we will turn to the second form of treatment: exposure therapy.
Exposure therapy
The CS-US association is housed in the amygdala, making it the trigger point for any of these fear responses. The ultimate goal of exposure therapy is to break this CS-US association, which is done through a process called extinction. Extinction happens when repeated exposure to the CS no longer elicits the arrival of the US (this is creatively known as a “CS-no US” memory). For Pavlov’s dog, extinction would occur if the buzzer (CS) was rung repeatedly without any food (US) showing up. The buzzer no longer indicated the arrival of food, so the old CS-US association is replaced by a “CS-no US” memory. As a result, the dog will stop salivating when the buzzer is rung.
For Sam, extinction would occur if repeated social encounters (CS) no longer produced the uncomfortable sensations (US) that would trigger the fear response. Since talking to someone no longer caused his heart rate to elevate and his face to flush, the emotions of fear and anxiety would have no reason to arise. While progress for cognitive behavioral therapy is determined by the client’s self-reporting of fear and anxiety, the efficacy of exposure therapy is determined by an actual reduction of physiological and behavioral responses. If Sam’s sweating decreases with each social encounter, that’s progress. If his face doesn’t flush as much as it used to, that’s progress.
Exposure therapy tries to close the door to anxiety by halting the rise of the uncomfortable sensations that start it in the first place. This is known as an implicit form of treatment, where we try to alter the nonconscious, automatic responses that are controlled by our nerve-wracked friend, the amygdala. By repeatedly exposing Sam to real and imagined social encounters, he can gradually learn that these situations are not dangerous, and the uncomfortable physiological sensations that would usually accompany them will start fading away. With each exposure, the surge of adrenaline and norepinephrine would lessen, and the CS-US link can be successfully broken
While all this sounds great, what is the neurobiological basis for extinction-based therapies like this? How does the age-old adage of “facing your fears” actually calm down the amygdala and reduce the freak-out capacity of the brain? [Kris: See original post for that as well as a list of specific types of exposure therapies]
While therapy is an incredible resource for the treatment of anxiety, sometimes it’s not easily accessible to the general public. Healthcare systems and stigmas around the world still have a long ways to go in the treatment of mental health disorders, so working with a therapist could be fiscally, culturally, and geographically unreachable for many people. Fortunately, our bodies and minds are equipped with some mechanisms that can help navigate us through anxiety-inducing situations without the usage of formal therapy as well. Let’s briefly touch two of these mechanisms that are inextricably connected with one another.
Breath and meditation
The DMN is what is active when you are lost in thought, or when you’re lost in what neuroscientists call “stimulus-independent thought.” Whenever your mind is wandering for no particular reason (scrolling through your social media feeds, daydreaming about a past event, etc.), your default-mode network is active; conversely, when you’re using attention to focus on external goal-oriented tasks, neural activity in the DMN slows down, which helps to induce those beloved experiences of flow states. Although much of the DMN is located in the Land of the Wise, it’s an area that isn’t very insightful a lot of the time. Studies have shown that a wandering mind is largely an unhappy one, and tends to focus obsessively on thoughts about oneself and his relationship with others. The wandering mind tends to conjure up thoughts about one’s past, one’s social standing in relation to others, reflections about one’s emotional status, visions of an imagined future, and all kinds of shit about the past and future. To put it simply, the DMN is the neurobiological epicenter for one’s sense of “self.”
When we are absorbed in mindless thought and are not aware of the states of our minds, the DMN is fully active and our sense of self is in full force. While feeling like you have a “self” and a distinct ego can seem comforting, the reality is that much of humanity’s problems come from the belief that we are the conscious authors of our lives. The feelings of anxiety and fear are no exception to this. Anxiety largely stems from an over-identification with the sense of self. Social anxiety’s roots lie in the erroneous beliefs of how others are perceiving your “self,” and generalized anxiety stems from worries about situations that can impact the well-being of your “self.”
It is through the constant belief in one’s distinct selfhood that we can fail to see our lives for what they really are: continuously changing pieces of the present moment.
If you’re scratching your head at this point, it’s totally understandable, as a lot of this stuff can sound pretty esoteric. If this whole “sense of self” section sounds a bit woo-woo to you, I get where you’re coming from, but there have been a number of fMRI imaging studies conducted on experienced meditators that shed some light on this. Daniel Goleman and Richard Davidson, leading researchers in this area, have found that the default-mode networks of seasoned meditators, many of which subscribe to the practice of “no self,” are substantially quieter than average levels. Additionally, studies have shown that the brains of long-term meditators have increased gray matter thickness, which is believed to protect age-related thinning of the cortex. LeDoux hypothesizes that meditation practices centered around “no self” prevents external stimuli from even entering working memory, thus isolating any memories about the self from one’s current experience. As a result, the practitioner is completely immersed in the present moment, as the brain is simply unable to take input from the external world.
Mindfulness practice can be invaluable to those suffering from anxiety disorders, as it allows discomforting physiological sensations to simply be observed for what they are: patterns of energy that ultimately have no real meaning. For Sam (our protagonist with social anxiety disorder), he can acutely feel the texture of his heart rate elevating, take a moment to study its character, experience it fully, then proceed to let it go as yet another appearance in consciousness. The elevated heart rate doesn’t have any particular meaning or lesson to convey; it simply arises and falls like everything else.
There’s a well-known quote attributed to Seneca that reads, “We often suffer more in imagination than in reality.”
Anxiety is the physical and emotional embodiment of that statement, and arises due to an unceremonious union of physiological sensations and erroneous beliefs. Concerns about a misinterpreted past and worries about an imagined future are the kindling for anxiety, and being aware of this can put out the proverbial fire before it even has the chance to start.
As we go on, living our lives in a world full of incessant change, it will be tempting for each successive generation to wonder if theirs is the defining era of fear and anxiety. Fortunately, the very thing that has created this exponential progress is also equipped with the ability to slow it down. The human brain, the product of a turbulent evolutionary process itself, can be used to amplify a false narrative about one’s anxiety, or it can take a moment to realize that this irrational tale can be rewritten.
I’m not a car guy and find vehicle shopping to be a mostly utilitarian exercise. No real taste. Car and Driver gives the car a high rating. Fine, whatever, put it on the short-list.
I actually love the aesthetics of cars and will go to car museums and car shows if it’s convenient. And sometimes when it’s not. On my birthday last year we went to Petersen’s in LA. I especially dig American muscle cars from the 60s and 70s. Ford vs Ferrari is one of my favorite movies of all time.
My mom claims when I was 4-years-old I would sit on the stoop in Brooklyn and be able to name the make of every car that drove down Avenue Z in Sheepshead Bay.
But path dependance interjected.
The summer before my freshman year of HS, on the way back from 6 Flags in NJ, I was asleep in the backseat. I awoke mid-spin. I can still remember what felt like a dream just before crashing into a telephone pole.
Confused I was feeling around and felt something moist.
It was my shin bone.
I was 13-years-old and panicked, throwing the door open, falling on the grass. The first responders were there quickly. I was in shock. But we were in a convenient location — the hospital was a mile down the same road. Apparently we were t-boned in the middle of an intersection where 3 nurses, late to work, ran a red light.
My mother was driving. She was fine. A close friend was in the driver seat, no seat belt. Unscathed. My sister was concussed and talking gibberish. I learned later my mother was most concerned about her since my sis’ behavior was really erratic and I just had a “cut”.
A 9” cut that took over 2 hours to thread with over 60 stitches and a summer of being on crutches but ultimately just a cut. (The skin on your shin is thin — the culprit was the pizza cutter shaped hinge that opened and closed the center console in the car.)
6 years later I was again asleep in the back seat of a car. It was about 7am. Me and a few college friends were driving from a Paul Oakenfold show in Montreal after being awake all night to Toronto for a rave the following night.
The driver fell asleep.
The Ford Taurus struck the median, ricocheted across a 4-lane highway to rest in the opposite shoulder. Every car behind us at 110 k/h dodged the “best-selling car in America” giving us all another day on Earth.
I tell my kids all-the-time, the most dangerous thing we do every day is get in the car. Maybe one day I’ll have a refurbished 70s Blazer as a beach cruiser. But the Ferrari posters on my teenage walls were the dreams of (literally) unscarred youth.
Peter Attia cited a stat that 90% of fatal car accidents happen at an intersection by a car coming from the left. That is exactly what happened to us that night coming back from 6 Flags. If today’s post does nothing but make you think of that every time you get to a 4-way, then I’ll never top this issue.
If a known event such as as a stock’s earnings date announcement we expect the market to assign extra volatility to any expirations which include that event.
Option traders will decompose such an implied volatility into:
A single day event vol or expected move size
The typical vol or move size for a regular day
If you were looking at a student’s grade in chemistry you know it was the average of the tests. But if the final exam has a bulk of the weight and the remaining tests were equally weighted you have no way of backing out with the final’s weight was.
The option’s trader faces a similar problem. How much of the implied volatility is coming from the market’s estimate of the event move size?
The best a trader can do is tinker with assumptions for the earnings or event move and then see what that implies for a typical trading day.
An “expected move size” corresponds to the value of a straddle. By converting straddles into an implied volatility for that single day, we can back out the volatility that is equally assigned to the remaining trading days until expiry.
The larger estimated event move, the lower the implied vol must be for the remaining days and vice versa.
Application: “Renting” The Straddle
Imagine a 30 day option on XYZ stock. XYZ is announcing earnings the morning of the option expiry date and you expect that the earnings move will be 4%*. Therefore you expect the straddle to be worth 4% right before earnings are announced or about 80% volatility (see straddle approximation calculator)
But what if it’s worth 4% today?
A 4% straddle with 30 days until expiry corresponds to an implied volatility of 17.5%
We expect the straddle to be worth 4% of the stock price just before the last trading day. A 4% straddle corresponds to an 80% volatility with 1 DTE
Therefore, the implied volatility must increase from 17.5% to 80% between now and expiration. This increase in implied volatility will exactly offset the theoretical option theta if the straddle has remained a constant 4% of the stock price over the course of the month!
If a trader knew this, they could buy the straddle today, hedge the gamma and then sell the straddle before earnings is announced. This kind of trade is known as “renting the straddle”.
This example is idealized. The trader got to “rent a straddle” implying zero volatility for all the days preceding earnings. It was free gamma. The example is meant to illustrate the idea that implied volatility is not distributed evenly across all days and by “extracting” volatility ascribed to events you can make better comparisons cross-asset.
*Perhaps by looking at how the name has moved on prior earnings dates. Estimating move sizes is an active area of research for practitioners. You can think of the problem inversely – you can try to fit the event size to your estimate of a fair trading day volatility. It is common to use this calculator in both directions.
Car leases are said to be “an option to buy”. Put-call parity is the most important concept to understand about financial options. At the core it really means a call or put can be turned into a straddle. An “option to buy” or call is also an option to sell.
I’ve talked about this a couple times in the past, most recently in Car Straddles. We usually lease our cars. We’ve bought some out and other times we’ve put the car back to the dealer after the lease term. If you are certain you want to own the car for long time, you should just buy it. You typically pay a premium for the option. It’s explained in that other post and in a prior one, Are Car Leases Confusing?.
We won nicely on our last Highlander lease we exercised the option to buy when used car prices were nuclear in early 2022. The used ones were trading higher than the new ones because the new ones were scarce/back-ordered. We exercised the option by trading the old one at a much higher price than the residual back to the dealer for the single Highlander on the lot. It happened to be the spec we wanted and the same boring ass white as our old one. This is called being lucky to have poor taste.
The questionable taste continues today. It looks like we are going to pick up a Hyundai IONIQ 6. I bring this up because the lease pricing is especially interesting for the next 2 weeks. My BIL, knowing we were interested in getting an EV, sent me this Slickdeals promotion:
This probably explains why I’ve been seeing a bunch of IONIQ 6’s on the road very recently in my area.
We did a family test drive of both the IONIQ 5 and 6 yesterday. It was high-fives all around — the wife and kids approved. Way more fun than the Highlander.
But let’s talk money.
The promotion is indeed real. The dealers are doing $10,000 rebate promotions. $7,500 comes from the EV tax credit — I thought there were income limitations on these yet the dealer claims there isn’t a limitation. He didn’t strike me as a reliable witness but regardless there’s actually a loophole where they are allowed to pass them on through on leases.
Being my tedious self, I needed to go home and play with spreadsheets. I wanted to compare how much it would cost to buy the car in cash (assuming an outright purchase is still entitled to the $10k rebate that occurs up front) vs leasing the car then buying it out for the residual in 3 years. My presumption is the lease method would lead to an overall higher cost because the option has value and I’ve seen this to be the case before.
Here’s what I compared:
Purchase
This is straightforward…how much would it cost to buy the vehicle in cash including the 9.25% sales tax plus the scroll of fees.
Lease
The cost:
full amount due at signing (down payment and bunch of fees)
+
the sum of payments over 36 months discounted to present value
+
the residual (including tax) discounted to present value
I used an after-tax required return of 3% for the discounting. This is a conservative estimate. The higher the number you choose the more valuable the lease option and I’m trying to evaluate the lease conservatively.
Here’s the output:
Bizarre. Look at the “lease option premium” which I define as the lease-implied cost minus the cash cost.
You are effectively being paid to own the option. And if you can earn more than 3% after-tax on the cash you don’t spend up front, the lease is even better!
Unfortunately, I wasn’t able to check the pricing for other vehicles to see if this was just a Hyundai thing. The reason I couldn’t complete the exercise is it’s very difficult to find the “residual” amount in dealer lease quotes online. Without the residual, you can’t evaluate whether the lease payments are a good or bad value.
The online quotes are not thorough and more concerned with coaxing you into giving them your contact info rather than creating firm asking prices. I checked the websites for at least 15 car dealers in the Bay Area and the only ones that provided lease quotes with residuals were Toyota Walnut Creek and Hyundai of Dublin. Toyota leases were also more attractive than buying but Toyota is historically aggressive on lease pricing so it wasn’t extra informative.
Anyway, if you’re car shopping, I noticed there were a few brands in addition to Hyundai with steep discounts until June 3rd as extended Memorial Day sales.
The subheading is a good enough teaser to this seemingly disagreeable, prolific mind:
A ruthless dissector of unwarranted assumptions takes on environmental catastrophists and techno-optimists.
Money Angle
Car leases are said to be “an option to buy”. Put-call parity is the most important concept to understand about financial options. At the core it really means a call or put can be turned into a straddle. An “option to buy” or call is also an option to sell.
I’ve talked about this a couple times in the past, most recently in Car Straddles. We usually lease our cars. We’ve bought some out and other times we’ve put the car back to the dealer after the lease term. If you are certain you want to own the car for long time, you should just buy it. You typically pay a premium for the option. It’s explained in that other post and in a prior one, Are Car Leases Confusing?.
We won nicely on our last Highlander lease we exercised the option to buy when used car prices were nuclear in early 2022. The used ones were trading higher than the new ones because the new ones were scarce/back-ordered. We exercised the option by trading the old one at a much higher price than the residual back to the dealer for the single Highlander on the lot. It happened to be the spec we wanted and the same boring ass white as our old one. This is called being lucky to have poor taste.
The questionable taste continues today. It looks like we are going to pick up a Hyundai IONIQ 6. I bring this up because the lease pricing is especially interesting for the next 2 weeks. My BIL, knowing we were interested in getting an EV, sent me this Slickdeals promotion:
This probably explains why I’ve been seeing a bunch of IONIQ 6’s on the road very recently in my area.
We did a family test drive of both the IONIQ 5 and 6 yesterday. It was high-fives all around — the wife and kids approved. Way more fun than the Highlander.
But let’s talk money.
The promotion is indeed real. The dealers are doing $10,000 rebate promotions. $7,500 comes from the EV tax credit — I thought there were income limitations on these yet the dealer claims there isn’t a limitation. He didn’t strike me as a reliable witness but regardless there’s actually a loophole where they are allowed to pass them on through on leases.
Being my tedious self, I needed to go home and play with spreadsheets. I wanted to compare how much it would cost to buy the car in cash (assuming an outright purchase is still entitled to the $10k rebate that occurs up front) vs leasing the car then buying it out for the residual in 3 years. My presumption is the lease method would lead to an overall higher cost because the option has value and I’ve seen this to be the case before.
Here’s what I compared:
PurchaseThis is straightforward…how much would it cost to buy the vehicle in cash including the 9.25% sales tax plus the scroll of fees.
LeaseThe cost:
full amount due at signing (down payment and bunch of fees)
+
the sum of payments over 36 months discounted to present value
+
the residual (including tax) discounted to present value
I used an after-tax required return of 3% for the discounting. This is a conservative estimate. The higher the number you choose the more valuable the lease option and I’m trying to evaluate the lease conservatively.
Here’s the output:
Bizarre. Look at the “lease option premium” which I define as the lease-implied cost minus the cash cost.
You are effectively being paid to own the option. And if you can earn more than 3% after-tax on the cash you don’t spend up front, the lease is even better!
Unfortunately, I wasn’t able to check the pricing for other vehicles to see if this was just a Hyundai thing. The reason I couldn’t complete the exercise is it’s very difficult to find the “residual” amount in dealer lease quotes online. Without the residual, you can’t evaluate whether the lease payments are a good or bad value.
The online quotes are not thorough and more concerned with coaxing you into giving them your contact info rather than creating firm asking prices. I checked the websites for at least 15 car dealers in the Bay Area and the only ones that provided lease quotes with residuals were Toyota Walnut Creek and Hyundai of Dublin. Toyota leases were also more attractive than buying but Toyota is historically aggressive on lease pricing so it wasn’t extra informative.
Anyway, if you’re car shopping, I noticed there were a few brands in addition to Hyundai with steep discounts until June 3rd as extended Memorial Day sales.
Money Angle For Masochists
This week, moontower.ai announced several free option calculators with more to follow.
💡These are embeddable so you can add them to your own websites, Notion workspaces, or wherever you organize your insanity.
If a known event such as as a stock’s earnings date announcement we expect the market to assign extra volatility to any expirations which include that event.
Option traders will decompose such an implied volatility into:
A single day event vol or expected move size
The typical vol or move size for a regular day
If you were looking at a student’s grade in chemistry you know it was the average of the tests. But if the final exam has a bulk of the weight and the remaining tests were equally weighted you have no way of backing out with the final’s weight was.
The option’s trader faces a similar problem. How much of the implied volatility is coming from the market’s estimate of the event move size?
The best a trader can do is tinker with assumptions for the earnings or event move and then see what that implies for a typical trading day.
An “expected move size” corresponds to the value of a straddle. By converting straddles into an implied volatility for that single day, we can back out the volatility that is equally assigned to the remaining trading days until expiry.
The larger estimated event move, the lower the implied vol must be for the remaining days and vice versa.
Application: “Renting” The Straddle
Imagine a 30 day option on XYZ stock. XYZ is announcing earnings the morning of the option expiry date and you expect that the earnings move will be 4%*. Therefore you expect the straddle to be worth 4% right before earnings are announced or about 80% volatility (see straddle approximation calculator)
But what if it’s worth 4% today?
A 4% straddle with 30 days until expiry corresponds to an implied volatility of 17.5%
We expect the straddle to be worth 4% of the stock price just before the last trading day. A 4% straddle corresponds to an 80% volatility with 1 DTE
Therefore, the implied volatility must increase from 17.5% to 80% between now and expiration. This increase in implied volatility will exactly offset the theoretical option theta if the straddle has remained a constant 4% of the stock price over the course of the month!
If a trader knew this, they could buy the straddle today, hedge the gamma and then sell the straddle before earnings is announced. This kind of trade is known as “renting the straddle”.
This example is idealized. The trader got to “rent a straddle” implying zero volatility for all the days preceding earnings. It was free gamma. The example is meant to illustrate the idea that implied volatility is not distributed evenly across all days and by “extracting” volatility ascribed to events you can make better comparisons cross-asset.
*Perhaps by looking at how the name has moved on prior earnings dates. Estimating move sizes is an active area of research for practitioners. You can think of the problem inversely – you can try to fit the event size to your estimate of a fair trading day volatility. It is common to use this calculator in both directions.
From My Actual Life
Random personal thing.
I’m not a car guy and find vehicle shopping to be a mostly utilitarian exercise. No real taste. Car and Driver gives the car a high rating. Fine, whatever, put it on the short-list.
I actually love the aesthetics of cars and will go to car museums and car shows if it’s convenient. And sometimes when it’s not. On my birthday last year we went to Petersen’s in LA. I especially dig American muscle cars from the 60s and 70s. Ford vs Ferrari is one of my favorite movies of all time.
My mom claims when I was 4-years-old I would sit on the stoop in Brooklyn and be able to name the make of every car that drove down Avenue Z in Sheepshead Bay.
But path dependance interjected.
The summer before my freshman year of HS, on the way back from 6 Flags in NJ, I was asleep in the backseat. I awoke mid-spin. I can still remember what felt like a dream just before crashing into a telephone pole.
Confused I was feeling around and felt something moist.
It was my shin bone.
I was 13-years-old and panicked, throwing the door open, falling on the grass. The first responders were there quickly. I was in shock. But we were in a convenient location — the hospital was a mile down the same road. Apparently we were t-boned in the middle of an intersection where 3 nurses, late to work, ran a red light.
My mother was driving. She was fine. A close friend was in the driver seat, no seat belt. Unscathed. My sister was concussed and talking gibberish. I learned later my mother was most concerned about her since my sis’ behavior was really erratic and I just had a “cut”.
A 9” cut that took over 2 hours to thread with over 60 stitches and a summer of being on crutches but ultimately just a cut. (The skin on your shin is thin — the culprit was the pizza cutter shaped hinge that opened and closed the center console in the car.)
6 years later I was again asleep in the back seat of a car. It was about 7am. Me and a few college friends were driving from a Paul Oakenfold show in Montreal after being awake all night to Toronto for a rave the following night.
The driver fell asleep.
The Ford Taurus struck the median, ricocheted across a 4-lane highway to rest in the opposite shoulder. Every car behind us at 110 k/h dodged the “best-selling car in America” giving us all another day on Earth.
I tell my kids all-the-time, the most dangerous thing we do every day is get in the car. Maybe one day I’ll have a refurbished 70s Blazer as a beach cruiser. But the Ferrari posters on my teenage walls were the dreams of (literally) unscarred youth.
Peter Attia cited a stat that 90% of fatal car accidents happen at an intersection by a car coming from the left. That is exactly what happened to us that night coming back from 6 Flags. If today’s post does nothing but make you think of that every time you get to a 4-way, then I’ll never top this issue.
While a successful volatility trader’s edge is in discerning relative value between options, they are agnostic on the direction of the underlying. This is a niche symbiosis in the ecosystem of markets. The Egyptian plover that cleans the gluttonous gator’s teeth.
The wider, active marketplace, with deeper pools of alpha, sets the price of underlying assets. Fundamental and macro traders have opinion on direction but are agnostic about the price of the options. Just as the vol trader assumes the underlying is “fair”, the directional trader assumes the options are “fair”.
(moontower.ai achievement is bringing a vol trader’s discernment about the relative value of options to the directional trader)
So it doesn’t surprise me that most option users just think of calls and puts as levered directional bets. But an option’s contract is a bundle that prices financing costs, volatility and time. To think of them as firstly as directional tools is to not fully internalize how deep an insight the put-call parity identity is.
The price of an option is primarily about volatility.
Trading the stock is blunt 2-D expression of a trade. Whether trading the stock directly or an option to express a thesis depends on 2 prerequisites:
The investor’s perception of the stock’s distribution over some period of time.
This is embedded in any decision to click “buy” or “sell”. How explicit any investor’s targets are and what rules they keep for changing their minds spans the gamut from “vibes” to code.
How that perception differs from the option market
To satisfy #2, you need to be able to interpret the what a vol surface is saying.
What does the straddle price mean?
What does a high or low skew mean?
How do I know if the skew is high or low?
What does the vol differential between months mean?
There are so many expiries and strikes, how do I discern which actions on which contracts at what size is the best expression of #1?
Or is the option surface saying that my view is “consensus”? In which case, the only reason to use the options is to sculpt your payoff profile for various scenarios. This exercise makes the trade-offs easily apparent.
[This sounds like a lot but on almost a daily basis I step people through questions like this in the time it takes to have coffee. Half the battle is the options are a second-language problem — and I don’t mean in the jargony sense — I mean it in the I-already-know-the-words-but-I-still-translate-them-instead-of-thinking-in-option-language-natively.
Which is probably why I have a habit of explaining option ideas with my hands automatically. Option sign-language is hockey sticks paths through time embodied.]
Over the years of talking to non-vol traders I have found that option users fall in 2 categories:
Levered directional players who do not understand that options price volatility and distributions (This discovery peaked during WSB/Reddit heyday and inspired How Options Confuse Directional Traders)
Investors with an intuitive understanding of options as distributional bets
You don’t need to have a view that sounds like “this option is priced at 24% vol and I think vol is going to realize 28%”. It’s enough to understand:
“I’m buying this call because if the stock is up 10% it’s up 20%” (conditional probability of discontinuity)
The distribution is more bimodal than the option’s market seems to think. One of my favorite examples of this was in The Big Short when the Cornwall guys bought far OTM calls on Capital One because they understood that when the bank was cleared by regulators the stock would be much higher. These were not option guys, but they recognized that the option’s prices didn’t agree with their expected value in what was a discontinuous scenario.
Practical tips
The following ideas are shareable parts of conversations I had with a family office that uses options.
On Risk Budgeting
I was chatting with a family office that uses options (outrights or vertical spreads only) on less than 10% of their trades. They are not vol traders but will use options for 2 reasons:
“Cornwall” reasoning — they believe the options are mispricing the distribution
They have a directional view but don’t want to be shaken out of the position due to path.
I’ve addressed #1 above as a great use-case for options. I remind everyone that options are priced for specificity — if you have a variant view of the market, an option is a highly levered exposure to your thesis being exactly right. (Which is why options are the weapon of choice for crooks trading on MNPI. And also why the SEC monitors unusual behavior in single stock options closely.)
#2 is another fitting use for options. I call it managing destination vs path. A small percentage of my trades also fit this pattern. A low delta call that you think is 4-1 to go ITM but if it does you expect it will pay 10 to 1.
This style of trade is called risk budgeting because you decide how much you are willing to lose in advance. “I’m willing to incinerate $1mm on these calls”. When I did such trades, I segregated the risk in an alternate view or what I called the “back book” (careful in the world of pod shops this term means something different — but I was calling it that 15 years when I was on the floor).
You segregate the risk because you don’t want to hedge the gamma or greeks that the option spits off. You’re betting on terminal value not path. If you hedge the gamma you are changing the payoff profile and can now lose more than your initial outlay. [If a stock grinds up to your long strike and expires you will lose the option premium. If you sell shares to hedge the delta the whole way up you lose on all those trades as well].
I asked these investors if they ever roll the OTM calls down if the stock falls? In other words is the terminal value target related to moneyness or absolute price.
What governs their rolling rules?
The answer was basically “feels”.
And I take no issue with that. I’m the last person who is going to condemn a trader for bringing the ineffable interpretation (I prefer “unstructured data”) of various moves into their decision process.
[Discretionary trading has an irreducible amount of “finger in the air”. Will some dolts lean on that as cover for their impulsiveness? Sure. What can I tell you — ambiguity is hard. But over enough reps, your judgement of a trader on a mix of performance and how they narrate their thought process is on more solid footing than your judgement of your primary care physician. Have a sense of proportion.]
The actual they gave was “well, if the stock goes down after we bought the calls we just accept that we were probably wrong and let it go”.
That was a bit head-scratching for me. Like the probability of the stock closing at a price at some point below the price it was when you bought the call is close to 100% (you could re-phrase this as “what’s delta of an at-the-money one-touch put?”).
The answer was a bit too low-res and self-defeating imo. After all, the majority of a stock’s move is systematic risk not “idio”. So the logic just collapses to “if the stock market downticks, we are wrong about this stock”.
I proposed:
What if you normalized the stock’s move by its beta and a confidence interval? So if the stock market is down, but your name is down by much less, than you were actually right on the name. How about test all those cases to see if a rule like
If market is lower, but stock outperforms then re-strike the option (ie roll the calls down)
There are still messy details like “how often” but this is an example of a wider lesson that I harp on — measurement not prediction. By measuring in absolute terms, you get one answer — “we are wrong”, but in relative terms you could be right. But the logical leap in how to measure comes from understanding reality clearly — every stock move is mostly systematic. It’s part of a basket that by index arbitrage imposes flows in the name based on what the index futures do.
Another thought
There’s an asymmetry to rolling. If you buy a 15 delta put and the stock rallies, vol likely declines. Even if the put skew increases, there’s a good chance that rolling the puts up will feel like a bargain compared to the opposite scenario — where you bought a 15 delta call, the stock falls, vol expands and the call spread you buy to roll down feels rich.
Rolling puts up feels better than rolling calls down.
I come from a tradition that needs to measure everything in pennies. So I might be splitting hairs to a fundamental investor. But it did remind me share something I like to do:
Throw everything in a scatterplot!
What’s the price of a 30d delta/10 delta call spread as a percentage of the spot price for various vol levels. This nets out the impact of ATM vol changing while the skew changes. Vol is lower but the put skew is higher. Ughh, just show me how much premium as a percent of spot that spread costs.
More scatterplot tips
1) Restrict ranges to consider conditional probabilities.
If you fit a regression line between vol level and put skew you will see that skew flattens as vol increases. If you restrict your sample to a regime (say to when SPX vol is sub 10%) that line will be steeper. If you were looking to buy puts, every time vol was cheap, you might be deterred because skew was in the 75th percentile. But maybe that same skew is in the 40th percentile conditional on ATM vol being below 10%?
[I will pull the data and show this picture in another post but I’m writing this off the cuff]
2) Color code the dots to show time
IYR realized vol has been falling and since the VRP ratio has been stable that means a short vol position has the wind at its back as both the IV and RV are declining.
via moontower.ai
You can hack your way to a lot of intuition by throwing data on scatterplots and jamming a line through it.
If you use options to hedge or invest, check out the moontower.ai option trading analytics platform
You might recognize “Wooderson” as Matthew McConaughey’s first cinematic role in the film that gave moontower its name.The speech is an all-time banger. The link includes my favorite takewaways but the speech should be watched on YouTube (link included in the post).
This year I add a third item to the commencement pack. I mentioned it on Sunday. It’s The Essential Paul Graham, a re-factored collection of excerpts organized by a few themes I find important. If you are at a crossroads or at the start of your career or even just in HS/college (especially in college actually), read it. Graham has been prolific so it’s not exhaustive but that’s also the point. It’s highly digestible in a single sitting. If you want more, the breadcrumbs are all there.
Maker’s Schedule, Manager’s Schedule (5 min read)
Paul Graham
I didn’t include this PG essay in the essentials because it’s a bit narrower but it’s a quick read that will resonate.
Excerpt with my emphasis:
One reason programmers dislike meetings so much is that they’re on a different type of schedule from other people. Meetings cost them more.
There are two types of schedule, which I’ll call the manager’s schedule and the maker’s schedule. The manager’s schedule is for bosses. It’s embodied in the traditional appointment book, with each day cut into one hour intervals. You can block off several hours for a single task if you need to, but by default you change what you’re doing every hour.
Most powerful people are on the manager’s schedule. It’s the schedule of command. But there’s another way of using time that’s common among people who make things, like programmers and writers. They generally prefer to use time in units of half a day at least. You can’t write or program well in units of an hour. That’s barely enough time to get started.
When you’re operating on the maker’s schedule, meetings are a disaster. A single meeting can blow a whole afternoon, by breaking it into two pieces each too small to do anything hard in…
For someone on the maker’s schedule, having a meeting is like throwing an exception. It doesn’t merely cause you to switch from one task to another; it changes the mode in which you work.
I find one meeting can sometimes affect a whole day. A meeting commonly blows at least half a day, by breaking up a morning or afternoon. But in addition there’s sometimes a cascading effect. If I know the afternoon is going to be broken up, I’m slightly less likely to start something ambitious in the morning. I know this may sound oversensitive, but if you’re a maker, think of your own case. Don’t your spirits rise at the thought of having an entire day free to work, with no appointments at all? Well, that means your spirits are correspondingly depressed when you don’t. And ambitious projects are by definition close to the limits of your capacity. A small decrease in morale is enough to kill them off.
Each type of schedule works fine by itself. Problems arise when they meet.
Interestingly, Graham recognizing the importance of both schedules, comes up with the same solution Cal Newport recommends: “office hours”. It’s also the same solution I basically came to — if you wanna chat, I send you a TidyCal where my time is preconfigured in an “office hours” way. I will put things in my calendar to nudge “stacking” so I can have uninterrupted half-day blocks to work.
Moontower.ai, besides being an analytics software, is also becoming a launchpad for anyone using or learning about options. To take full advantage of the free tools just sign up.
Read the Primer – it’s broken into short written essays, to make it digestible. The first 7 posts are the core philosophy. It reads quickly and is strongly recommended. The remaining posts comprise the Implementation Unit. They follow a logical sequence but can also be used as a reference to understand particular tools.
Check out the Moontower Mission Plan [coming soon!] – this document is a hybrid of worksheet/flowchart for various use-cases whether you are looking to put on a directional bet, hedge, or make a volatility play such as selling covered calls.
For the analytics and community features a pro subscription is required. As you may expect, a common question we get:
Do you think moontower.ai is worth the investment for someone who has limited option knowledge or time❓
Back in 2000, I joined the Assistant Trader program at SIG out of college. The deal was that you spend 6-18 months in rotation before they send you to headquarters for 10 weeks of intensive training. Competition to get accepted into the training was intense because it was only held 4x per year. You were given a raise from $37,500 to $50k when you got accepted to it and, if I remember correctly, another raise to $60k when you completed the course and got assigned your trading job.
[Acceptance to the class was conditional on signing an extremely strict 3-year non-compete. That non-compete had several provisions that went well-beyond 3 years and ended up being the reason I switched from oil options trading to nat gas when I left the firm.]
As an assistant trader, or “clerk”, you’d support one or more option or ETF traders during market hours then compete in classes and “mock” after work from about 4-6pm. (And for that first year out of college you’d spend several nights a week playing poker for another 2-5 hours. It was a good thing at the time. We were insufferable though. If you bugged the room you’d die of cringe to hear “I’m 60 delta to hang out this weekend”.)
Mock trading was usually a simulation of option market making in an open outcry setting. But sometimes we played games. Since I clerked for several people that became early partners at Jane Street I suspect this particular game was a precursor to Figgie.
When I graduated from trading class in the summer of 2001, I was assigned to an option pit on the American Stock Exchange where the most active names were AIG, GLW, Q, and EK. My total coverage was about 30 names.
I was actually delayed by a month in getting my “badge” or license to trade — I was supposed to start the week after 9/11 happened.
Do you have any insight into the activities of market makers when they act as authorized participants in the ETF market?
If you ask the internet how market makers earn profits, the typical response is something like “by capturing the (bid-ask) spread.” I have always wondered how “capturing the (bid-ask) spread” can be so enormously profitable and consistent.
I have been looking at deviations of ETF prices from net asset value and am now under the impression that “spread” means something totally different to the market maker (in particular, authorized participants).
Am I way off here?
My answer below, plus some story-telling on ETF options and option market-making generally:
ETF market-maker life
I was an ETF market maker for SIG for a bit and we were APs.
It makes more sense when you remember that liquid names in anything don’t really need market makers because there’s enough organic liquidity.
[Aside: This is a broadly useful insight — it’s an important part of the meta of when and where to shift gears back-and-forth between position trading and bookmaking]
To answer the question:
there is a very long tail of ETFs that might have plenty of edge in them but just don’t trade lots of volume.
the cost to create/redeem is very low and large mm’s have economies of scale (good funding rates, low commissions, fast execution) so they can make money with 1/2 cent of edge on a trade.
published intra-day NAVs are often wrong especially when you get into more complex ETFs (the spreadsheet to price HYG or FEZ is a giant book with many assumptions because there’s a staleness in the prices of the underlying components — so you need a model for guessing what the fair current price of the components are — think of a European ADR price after the local market has closed but the US is still open — you might “beta” the stock to the SPX from when the local market closed while adjusting for the currency-cross tick by tick)
There are several firms that have built large businesses on the back of trading ETFs across time zones and internationally as the markets open from Asia to the US. Billions of dollars have probably been made on this in the past 2 decades. [Redacted list] of under the radar places all made this their bread and butter. In fact, they were way more focused on this than options.
US equities were super competitive back in 2004-2005 when I was doing this — and that’s even after adjusting for SPX futs prem/discount.
To explain that more clearly:
we’d compute the current price of SP500 basket using direct data from the exchange feeds
add the fair value of the EFP (cash-futures swap) to create the fair value of the synthetic future
then compute the premium-discount by subtracting this synthetic from the actual SP500 futures price. If that number was positive we’d say the futures were trading “over” by say 10 bps or whatever that premium represented.
we’d then beta weight the ETFs by that premium to predict the true fair value of the NAV (basically this all comes down to the fact that futures lead the cash)
This was standard practice 20 years ago if not more.
A few more tedious details:
We were computing NAVs based on the files sent to us by the actual ETF sponsors every morning including how much cash on hand the (this was called a “cash plug” in our lingo) sponsor had in the ETF portfolio based on the prior day’s create/redeem activity.
Computing the fair value also requires knowing the true borrow rate for every name because that is an input (although that can sort of be aggregated from knowing the EFP market since it should be incorporated into the cash/futs arb).
The general tradeoff you’ll face
More liquid names will have no edge but you can execute.
Less liquid names might have flow-driven mispricings that market makers are not closing (because they might know a premium is going to become more premium for example) but execution is harder.
Also, there’s massive adverse selection in this — if you are getting filled easily there’s a problem. When you get into the nitty-gritty of ETF arbitrage you are in the realm of understanding the prospectus — market makers trying to pick off other market makers based on some small legal gotcha or upcoming reconstitution of an index (I’m vague on the details but I remember the Holders ie TTH, SMH going thru some change that a few market makers recognized before the rest and picked them off by dumping long dated option premium on them that was about to evaporate. That one might have ended up in court.)
Shifting to options now…
Here’s one to ponder:
Option quotes are streamed in accordance to where a market maker thinks they can get their hedge off in the underlying. Typically the options will be priced off the mid of the stock’s bid-ask.
But if a market-maker is quoting ETF options and believe the NAV is different than the midpoint what does that mean if the option customer gets filled?
Option market maker life
Capturing the bid-ask is more cloak-and-dagger than the simple spreads you see on the screen. A professional market maker can see the screens, but their job is constantly update “what’s the true bid and true ask?”
A friend who was the lead mm in a semi-liquid options market used to describe his job as “throwing dust in the air so nobody sees where it really is”.
An options market with sparse or wide screens might trade way tighter via voice (especially in ETF options). The screens can be framed however in anticipation of an order or to entice someone to buy or sell.
Trying to figure out fair value in a name that trades by appointment is like trying to catch fireflies that blink every so often. The 3-month 25d put just traded near the offer…is vol higher or is put skew higher? If the straddle was offered by another party at the same time then the skew is probably just higher now. Maybe the straddle seller is making a statement about vol since they are, well, trading a straddle but the put buyer is betting on direction. In that case, maybe I pass on the straddles, sell the puts and hedge their delta and wait for the straddle seller to step down even cheaper. Then I’m synthetically legging ATM/25d put spread for a cheap price. Sizzler’s on me tonight.
But what are the chances the straddle seller is going to step down and lower the price? Have I seen the signature of this order before? Can that help me handicap their tendency?
What about the put buyer…do I think I’ve seen them before?* Do they tend to be smart on direction? In that case I want to hedge the put sale on a “heavy” delta.
All of a sudden a call buyer shows up in a deferred month. Do I think the term structure is shifting? Which one of these orders is the most aggressive?
If this sounds like fun it actually is. You are playing Sherlock Holmes in real-time with quick feedback. Especially if there’s so much action that there is 2-way flow simultaneously. If any of you came to the mock-trading sessions we did for StockSlam/Pitbulls you know the feeling of needing to hold a bunch of info in your head at the same time, maintain your ability to listen, and quickly react before the right trade is obvious to everyone else. Which is why experience and feel are crucial — you need to maximize the ratio of “good decision” to “how much info I need”.
Slow and stupid are indistinguishable in the market-making game. It’s not good enough to be “faster than average” in a winner-take-all ecosystem.
*People wonder how you can know “who” it is. You can’t know for sure, but you are pattern-matching. Have I seen an order of similar size, aggressiveness, time of month, moneyness, thru this particular broker, and so on. And if you roll, you’ve shown me the Monty Hall donkey.
Look, if you’re an account trading options in the voice market you are probably a repeat player. Maybe you have a periodic hedging program. Maybe you keep coming back because you’re winning. Oh, I remember trading against Mr. “This-Is-The-End-Of-The-Order”.
And brokers themselves have niches. When I hear a French accent I already know what class of customer is on the other side of the phone.
“Allo, dis is ah bee-yair”
Hi Pierre. I assume you will be joining the screen bid?
“ah-ah, yoo noh meh too well”
I’m going to level with you mon frere. It’s a rev/con. I’ll still be bid there myself next Monday.
“vat ah-boot for hahf koh-mee-see-on”
See, Pierre, the Royal Pierre who stands in for the French national pastime of clinically computing hedge ratios to 14 decimal places, is more price sensitive than extreme couponers because his client is protecting the margin on a structured note sold to private wealth account and the sales team get 99% of the p/l attribution, while the exo trader shakes a tin can on Wall Street for someone to pair off risk at fair.
Now the regional broker based out of Florida — he I’ll pay double comms to fund his cargo-short wearing client’s appreciation of Mermaid’s dancers.
So sure, the market maker doesn’t know the client’s blood type. But it’s hard to fool people twice.
My friend Rajiv Rebello has helped both my family and extended family navigate the complexity of insurance contracts. That world is coated simultaneously in both exploitive grease and heavy regulation. Rajiv is our white knight. Brilliant, honest, and experienced. He’s an actuary who help individuals find policies and understand the opaque pricing and incentives. He has helped buy-side firms price policies as investments.
“Rajiv, pretty please explain what the hell is going on here in more detail for Moontower readers”.
He hits it out of the park.
He breaks down the incentives, arbitrages, pricing and chicanery in the life-settlement primary and secondary markets. And you will learn plenty about insurance that is directly actionable and applies to your own policies!
Before we start, give his Substack a follow (especially since I selfishly asked him to start one): Separating Value From Bias
Life Settlements: A prime example of markets finding a way—albeit in an unbelievably messy fashion
When it comes to financial decisions, humans tend to behave in ways that are suboptimal and not in their best interests—and entire industries are made to profit off this. The only thing that holds them accountable is another industry trying to make a profit off the first.
When the first Jurassic Park movie came out in the summer of 1993, I, along with the rest of the country was blown away.
I was only 12 years old, but had never seen anything like it.
For god sakes, they brought dinosaurs to life.
If you haven’t seen the movie, here’s a quick synopsis: A couple of paleontologists visit a secret animal park that’s managed to clone dinosaurs and bring them back to life. They’re supposed to go on a straightforward tour of the park and give their approval so that they can open the park to the public.
It’s supposed to be a very controlled experience with numerous safety protocols and checks and balances to prevent anything from going outside of what was planned.
There’s a line in the movie that summarizes the gist of it well. One of the scientists of the park is trying to explain how the dinosaurs in the park can’t reproduce because they were genetically engineered to all be female.
To which, Jeff Goldblum’s character—whose primary role in the movie is to point out the human folly in trying to suppress the insuppressible—says:
“If it’s one thing the history of evolution has taught us is that life will not be contained, life breaks free, it expands to new territories and it crashes through barriers, painfully, maybe even dangerously, but……
…life finds a way”
And as we’d later find out, all hell breaks loose, life finds a way, and the best laid plans of mice and men oft go awry.
I can replace that same Jeff Goldblum quote except by replacing “life” with “markets” that perfectly encapsulates the life settlement industry.
“Markets will not be contained, markets break free, they expand to new territories and they crash through barriers, painfully, maybe even dangerously, but…..markets find a way”.
Since Moontower often takes deep dives into how opposing counterparties of a trade value an asset and the psychologies involved, I thought it might be worthwhile for readers to explore the life settlement industry from the position of a counterparty trying to even out an asymmetric imbalance of power and control between the life insurance industry and the consumer.
Ultimately the life settlement industry is forcing the life insurance market to be less predatory with its own consumers—it’s just that the life settlement industry is using the same exploitative tactics that the insurance industry is in the first place.
Matt Levine/Life Settlement Summary
Matt Levine’s article centers around the story of a $5 million life insurance policy that was sold to a woman in her 70s.
While this sounds like a non-descript transaction, the unique element of the story is that an investment entity—unrelated to the elderly woman (i.e. the insured)—paid for the premiums on the policy on condition that the investment entity would receive the death benefit when she passes.
On top of that, the investment entity paid the insured a $150,000 bonus as an incentive to apply for the policy all so the investment entity could have the obligation of paying all the premiums on the policy and the right to receive the death benefit when she passed away.
In a life settlement transaction an investment entity pays the insured on a life insurance policy an upfront price in exchange for ownership interest in the policy. The investment entity then pays all premiums on the policy going forward and receives the death benefit when the insured passes away.
You might be wondering why an investment entity would do this.
The transaction, when done properly and legally (i.e. not what was done in this case) is called a life settlement.
A life settlement is when an existing policyowner of a life insurance policy sells his or her interest in the policy to a third party for an amount larger than he or she could get if the policy were just canceled.
This particular transaction wasn’t a legal transaction because the investor can’t entice the policyowner to buy the policy in the first place. Doing so violates the insurable interest provision required of a life insurance policy since an outside investor who doesn’t know the insured doesn’t have a vested interest in the insured staying alive.
The investor can only legally acquire the policy after the insured purchased the policy on his or her own without influence from the investor.
While the Levine article gives off the idea that there are a lot of illicit transactions happening in the life settlement space, the truth of the matter is that this policy was issued back in the mid-2000s when there was a lot less regulation of the space than there is today.
Today this transaction would have been most likely caught in the due diligence phase of the life settlement process and wouldn’t have proceeded.
The reason why the investors in this case enticed the policyowner to buy the policy and sell it to them in violation of the law was because they saw a huge arbitrage to be made between the cost of acquiring the policy (premiums to the insurance company and payout to the insured) and the value of the death benefit.
The investors believed they had an upper hand over the insurance company that was worth them violating the law.
Levine quotes this as being a pure mortality bet, that’s not the full story.
Remember that the insured was applyingfor a life insurance policy. Which means she would have had to get a medical exam and all her medical records would had to have been sent to the insurance company.
So it wasn’t a pure mortality arbitrage here. The insurance company had the same medical information as the investment entity.
The arbitrage came from the fact that the cost of the insurance policy relative to the health of the insured was low and the investment entity planned to pay premiums on the policy in a manner that exploited this.
The investment entity was exploiting the pricingdesign of the life insurance policy as opposed to just a bet on the mortality of the insured.
Which should bring up an interesting question for you as a reader.
Why would an insurance company ever design a policy in which the cost of insurance they were charging was lower than the underlying mortality cost of the insured?
The answer is that they expected that the policyowner would behave in ways that would reduce their risk of having to actually provide that insurance.
Pricing of a Life Insurance Policy
In order to understand why an insurance company would charge a cost of insurance that was less than the cost of mortality, you need to understand how a life insurance policy is designed.
We all know that the chance of someone dying increases as they get older.
If you were to design a life insurance policy the natural assumption would be to charge a cost of insurance that was higher than the cost of mortality for every year that the insured was alive.
So for example, if there was a $1M policy and there was a 1% chance of the person dying in the first year, that means you would expect a $10,000 loss due to that policy. So if you wanted a 10% profit margin on your risk you would charge $11,000. That would give you a $1,000 profit.
Analogously, in the second year if there is a 2% chance of the person dying, to keep that 10% profit margin you would charge $22,000. Now you have a $2,000 profit in the second year.
If you were to price a life insurance policy like that the economics would look something like this:
Normal Profit Margins of a Company
A normal profit structure is to charge a cost of insurance to the customer that is a fixed percentage over the underlying mortality cost of providing that insurance.
We can notice a couple of things here.
While the profit margin is always 10% greater than the cost of mortality, the absolute value of the profits increase over time because the underlying cost of mortality increases over time.So the bulk of the profits come in the later years.
Equivalently, the insurance company could price the product such that they take larger profits in the earlier years and then losses in the later years.
Unequal Profit Structure
An unequal profit structure charges a cost of insurance (orange line) that is significantly higher than the underlying cost of mortality (blue line) in the early years and a cost of insurance that is lower than true cost of mortality in the later years
While the chart isn’t exactly drawn to scale, you might notice that the losses in the later years are larger than the profits in the early years. However, remember that the net present value of those later year losses are smaller than the profits in the early years.
In both pricing examples, the net present value of the profits are the same as the earlier chart which charged a cost of insurance that was always a multiple of the true cost of mortality. So the insurance company would, in theory, be indifferent.
While the second pricing design introduces a future liability, part of the large profits in the early years would be used as a reserve to meet those future liabilities.
Premium and Lapse Supported Pricing
However, it’s important to note that policyowners typically behave in ways that significantly reduce the cost for the insurance company to provide the insurance:
They pay more for the mortality cost in the early years of the policy and less than the mortality cost of the policy in the later years
Most of you reading this probably have a term life insurance policy to protect your spouse and kids. Maybe you got a 20 year term or 30 year term policy. However, even though the chance of you dying increases as you get older the premium you pay every year is the same regardless if you are in year 1 or in year 30.
What this means is that you overpay the cost of the policy in the early years, and you underpay the cost of the policy in the later years.
Level Premium Payment vs Underlying Cost of Mortality
When you pay a level premium into a policy with increasing costs, you are essentially overpaying the cost of mortality in the early years and underpaying it in the later years
So the cost of you dying earlier in the term is partially offset by the fact that you also overpaid for the policy in the early years as well.
This further reduces the liability for the insurance company—especially when we consider the fact we mentioned above about policyholders paying more than the cost of the insurance in the early years of the policy.
It’s a win-win for the insurance company: you pay more than you should in the early years of the policy and then you cancel the policy before it ever gets to the part in the term in which you are underpaying it.
The insurance company collects excess premiums for the coverage they offered you.
This is why an insurance company can design a policy that has high profit margins in the early years and large liabilities in the later years. The insurance company expects the profits to materialize in the early years and the liabilities in the later years to never come due.
When insurance companies do this too aggressively, it’s called lapse-supported pricing. “Lapse” is insurance jargon for “cancel”.
While not all life insurance companies are this aggressive in their lapse-supported pricing, all life insurance policies are based on the design of a large number of policyholders paying a level premium — overpaying in the early years and then canceling before they can ever receive the benefit.
Policyholders are humans. And humans act on emotions which they use to justify their logic instead of the other way around.
Insurance companies know this.
Policyholder behavior reduces the cost of mortality for an insurance company. This increases the present value of the insurance companies’ profits and reserves and reduces their future liabilities.
Policyholder Behavior Reduces the Underlying Cost of Mortality of a Life Insurance Policy
Policyholder behavior reduces the insurance companies’ underlying cost of mortality from the blue line to the green line. This increases the insurance company’s early year profits and reduces the future year liabilities for the insurance company.
It also reduces the cost of the insurance to the policyholders who keep the policy for the long-term at the expense of those who do not.
If everyone were to keep the policy and behave the way an optimal investor would, the cost of your life insurance policy would be 2.5-3 times higher than it currently is.
So if you have a life insurance policy and are actively paying the premium, you should thank the 60%-70% of people who pay more than they should and cancel it early for subsidizing your policy.
What the investors in the Matt Levine article did was identify life insurance companies that were using a high degree of lapse-supported pricing. They realized that if they purchased enough of these policies on elderly individuals and paid just the cost of insurance on the policy and nothing more, they could profit off of the design of the policy by acting in ways that the average policyowner wouldn’t.
It allowed these investors access to an investment in which the underlying cashflows were not correlated to equity markets. By acquiring multiple policies on multiple insureds, it allowed them to diversify their investment risk.
Exploiting the Insurance Company that is Exploiting its Customers
Back in the mid-2000s when the policy in the Levine case was sold, overly aggressive lapse-supported pricing in the life insurance space was a lot more prevalent than it is today.
If you think about it, it’s an almost perfect design.
The design reduces the cost of mortality for the insurance company. This means that the insurance company can reduce the premium it charges for the insurance product.
Which of course means it can sell more policies since it’s a cheaper product and capture a larger share of the market in comparison to its competitors that don’t use that design.
The problem comes about when sophisticated investors like the ones in the Levine article act in ways that maximize the value of the policy as an investment for themselves at the expense of the insurance company.
When investors do this, all of a sudden those large future liabilities that the insurance company never expected to come due are in fact poised to come due.
However, insurance companies have an out here which is protected by law.
Insurance companies are allowed to use future assumptions to price their life insurance products. If those future assumptions with regards to policyholder behavior prove to be inaccurate they can later say, “whoops, my bad” and increase the cost of insurance for all policyholders.
It’s another win-win for the insurance industry.
Price the product below the true cost of mortality to gain market share and collect early profits. If you end up being wrong later, just increase the cost of insurance across the board for all your policyowners who purchased a long-term contract from you and are now stuck with it.
If this seems deceptive and like a bait-and-switch, it more or less is.
Doing this not only damages the brand and reputation of the insurance company at hand and they expose themselves to large class action lawsuits.
This is indirectly saying that they expected their policyholders not to be sophisticated and NOT to act optimally.
The pricing design only works the way it’s expected if the insurance company is exploiting individual policyowner behavior and those policyowners are not en masse using the policy design of that said insurance company in a way that benefits the individual policyowner.
Which is, of course, where the life settlement industry comes into the fray.
Life Settlements: Exercising an Embedded Option While life insurance companies can increase the cost of insurance across the board for policyowners based on aggregate policyholder behavior or mortality assumptions, they can’t do it on an individual level.
For example, if you are in great health when you buy a life insurance policy and then a couple of years later put on a lot of weight or have a serious health event, the life insurance company can’t raise the cost of insurance even though the chance of you dying has increased.
There is a mortality arbitrage between the cost of insurance of the policy and your underlying health.
The policy, as an investment, is worth more now than it was when you bought it.
However, the insurance company won’t compensate you for this additional value.
If you can’t afford or no longer want to pay the premiums on the policy you have limited recourse other than canceling the policy for a fraction of what it’s worth—which is of course what the life insurance company is expecting you to do.
This is where the life settlement industry steps in.
It understands there is value being lost here and helps bridge the gap between the low value the insurance company is offering you if you cancel versus the intrinsic value of the policy as an asset.
So when you buy a life insurance policy, you are also getting a free out-of-the money put option from the life settlement market—it’s just that the insurance company doesn’t want you to know about it.
That option only becomes in-the-money if you have a health event that changes your underlying cost of mortality, or the pricing design of the underlying insurance product can be exploited, or some combination of both.
If your only options are to cancel the policy or sell it on the life settlement market, you are undoubtedly better off exercising that option and selling it on the life settlement market.
That being said, you and your family are better off keeping the policy and paying the minimum cost of insurance until you pass away because of the economics involved than selling it in the life settlement market.
In the case example we discussed above, the insured was paid $150,000 upfront so that the investors could pay the premiums and receive the death benefit when she died.
However, if the insured would have not taken the upfront offer, and knew to pay only the cost of insurance and not more, she could have paid the premiums and received the $5M death beath benefit tax-free. Her tax-free IRR on the transaction would have probably been close to 20%.
It’s hard to beat that elsewhere.
Instead the insured received a fraction of that value so that the life settlement investment entity on the opposite side could take the longevity risk and receive the bulk of the rewards.
Life Insurance Industry vs Life Settlement: Choosing between the Velociraptor and the T-Rex
In the climactic scene of Jurassic Park at the end of the movie, the velociraptors trap the paleontologist and 2 kids in a museum and are about to pounce and eat all of them when the T-rex busts in the door and starts attacking the raptors allowing the paleontologist and the kids to escape.
Life Insurance vs Life Settlement Company: Trapped Between Two Predators The life insurance company and the life settlement company create an environment that makes it easier for the policy owner to escape. But you don’t want to be trapped in a room alone with either of them.
That’s how I look at the battle between the life insurance industry and the life settlement space.
The life insurance industry is like the raptors.
The whole movie they have created an elaborate trap for you to walk into without you realizing that you’re walking into it.
Because that’s what people do—we walk into traps.
The only thing that ruins their trap is another brutal goliath also looking to devour you.
The life settlement industry doesn’t have your best interests at heart either.
When you sell a policy your the life settlement market you pay 15% to 30% in commissions just to give an investor the opportunity to purchase your policy and make a 15% to 20% IRR that you could have been making if you kept the policy.
They are the T-rex in the scenario.
Being trapped between the two isn’t the ideal situation to find yourself in.
But much like the protagonists in Jurassic Park, it’s the fact that the one monolith opposes the other that gives you the chance to walk away without being completely eaten alive.
On Markets Always Finding A Way
And that’s why markets always find a way.
One party can lay a trap for an innocent passerby, but as soon as another party realizes that they can eat off that same trap too, they’ll find a way to disrupt the first party’s business model.
It’s why Dennis in Jurassic Park turned off all the safety systems and tried to escape with dinosaur embryos so he could sell it to someone else.
The reason why the life settlement industry is messy and inefficient as opposed to other disruptive industries is simply because it can afford to be.
It’s not like other industries where you have to struggle to add additional value just to compete.
There’s plenty of profit to be skimmed off the consumer without them understanding the value that’s being lost.
The consumer is ill-informed and buying off emotion rather than logic or value.
That’s what led them to be stuck in the trap in the first place.
But Jurassic Park only works the way it’s supposed to if the animals in the park behave the way they’re expected to.
As soon as they start to test the boundaries and limitations of the fence it built to contain them, it has a problem.
If the average consumer understood the trap being laid for them, they would have exploited it for themselves instead of needing the life settlement industry to help them do it—all while the life settlement industry keeps the bulk of the economic benefits for itself.
The consumer is just a pawn being played in the middle of a trap they don’t know they are in.
They lose on the front-end when they buy a life insurance policy they don’t fully understand how to utilize in their best-interests.
And then they lose on the back-end when they sell an asset on the life settlement market for a fraction of what it’s worth.
The calamitous effects on the end consumer in the life insurance and life settlement industries highlight some of the most problematic elements of capital markets that invariably bring up questions of fairness and equality.
Is it fair that a large majority of policyowners overpay for a product so that a few can get the benefit?
But then if I ask you if you want to pay 2.5-3 times more for your life insurance policy you’d also say no.
But you can’t have one without the other.
Is it fair that if a policyowner can no longer afford or no longer needs their life insurance policy their best option is to sell it on the life settlement market for only a fraction of what it’s worth?
Again, you might say no.
But if it wasn’t for the life settlement market you’d cancel the policy to avoid the obligations of future premium payments that you can’t afford or don’t want to pay and receive a much lower payout from the insurance company than what the life settlement industry is willing to provide.
So what’s the answer here?
The answer is for more people to understand the mispriced opportunities in the life insurance market and exploit them in the same way and start making better decisions.
And the opportunities here are endless because they’re all designed around poor policyowner behavior and consumers making bad decisions.
It’s not like traditional capital markets where in order to get an advantage you have to be smarter than the trader on the opposite side of the table who has a PhD in statistics and decades of experience.
In this case, you just have to make better decisions than the average consumer.
So if you and a friend are being chased by the velociraptor that is the insurance industry and trying to gain an advantage, you don’t have to be faster than the raptor to do it.
You just have to make better decisions than your friend.
And your friend is making poor decisions based on emotional biases over a product he or she doesn’t understand.
It’s not rocket science, but does require intention, discipline, the willingness to learn and admit your flaws, and find people with the right expertise and intentions to assist you.
Exploiting these loopholes forces the industry to adapt.
Aggressive lapse-supported life insurance products are no longer as prevalent in the life insurance space as they were in the mid-2000s in part because the industry got burned heavily from life settlement investors exploiting this design.
Competition is what forces industries to deliver higher value to its consumer.
In the absence of this competition—and a misinformed consumer base—there is no incentive for the life insurance industry to change.
It’s easier for the life insurance industry (and many other industries) to just sell its consumers a story based on a false expectations and have them fall into the trap it designed for them.
About the Author
Rajiv Rebello is the Principal and Chief Actuary of Colva Insurance Services. He helps HNW clients implement better after-tax, risk-adjusted wealth and estate solutions through the use of life insurance and annuity vehicles.
He also writes a Substack called Separating Value From Bias where he explores inefficiencies in the financial and insurance space and how to utilize financial planning tools more effectively while connecting these issues to broader capital and social systems.
The importance of finding the people who inspire you via Bill Gurley’s Running Down A Dream speech
Keep in mind, this is the mid-1960s. There’s not many film schools in the United States. And so this is why Tarantino last week in his book would talk about the movie brats. He said they love movies, they dreamed of movies, and they even received degrees in movies back when that was a dubious major. And Lucas talks about this like it was embarrassing. Other people were like, you’re going to a film school, they didn’t even call it a film school, they call it cinematography school. “Like what the hell is this?” and he says, “I lost a lot of face.”The idea of going into film was a really goofy idea at the time. His dad’s like “there’s no way in hell, I’m playing for art school”.
That decision changed the trajectory of George Lucas’ life is because that’s when he meets essentially just a collection of filmmakers who are all obsessed with movies, they’re all young, and they wind up helping each other for decades. It’s almost like the island of misfit toys because before this, it says, for many of them, it was the first time they had a click of their own, a gathering place where they could talk about their interest, movies without eye rolling from the other cool kids. For many reality finally began when they entered film school.
Lucas knew that he had found his way. Before he wasn’t sure, obviously in the college he had all these other interests. And he’s like, “Oh, wait, this is it.” I was sort of floundering for something. “And when I finally discovered film, I really fell madly in love with it. I ate it. I slept it 24 hours a day. There was no going back after that.”
Steven Spielberg describes, he uses the exact same language. This is what Spielberg said, “Making movies grows on you. You can’t shake it. I like directing above all. All I know for sure is I’ve gone too far to back out now. There is no going back.” They both discovered what they’re going to do.
Now this is the fascinating part because this turns into the USC Mafia, Spielberg is part of that, even though he didn’t go to USC. You’re talking about a group of super talented filmmakers and a lot of them come out to California, even though they called the USC Mafia, some of them like Martin Scorsese, Oliver Stone, they went to NYU, Brian De Palma went to Colombia. Francis Ford Coppola was at UCLA, Spielberg is on the lot getting his own curriculum at Universal.
They were all friends who would have a lasting impact on film and culture. This is another example that relationships around the world. You see it over and over again in these books, so important to develop relationships with other people that are just like you and even if you’re — they don’t look at themselves as competitors. They tend to compete, but they also collaborate, but they all need each other because they’re trying to break into a system that is closed.
At this point in history, unless you’re part of a union, unless you already know somebody in the industry, you’re not breaking it even with a film degree. It’s yet another illustration of one of my favorite concepts from Game of Thrones, where they said those on the margins often come to control the center. At this time, Spielberg, Scorsese, De Palma, Coppola, Lucas, they are on the margin.
The center is controlled by these old school conservative studios that are locking all these young people out. It was unheard of to have a director in their 20s. And yet this network that they’re building and the talent that they have for their craft, like those on the margins often come to control the center. They become the center.
Now this is really fascinating because when I had dinner with Charlie Munger, this is the advice that he gave us. He talked about is exactly what him and Buffett did. I think he was 35 when he met Buffett, Buffett was about 28, 29 something like that. Each talked over and over again, the importance of — the advice he gave was like you have to develop relationships with people. He’s like, they were still doing deals. He talked about the fact that they would meet people in their 20s, 30s and 40s, and they would do business and do deals for the rest of their lives. The USC Mafia would regularly hire, fire and conspire with one another on countless projects over the next five decades, putting together a kind of system of their own. Lucas is 23 when he meets Coppola. Coppola is 28. They’re going to be making movies doing deals, starting companies, breaking up, fighting for decades.
It’s really important because at that time, because there is no young directors. There’s no 28-year-old director doing a major movie set. You have to be an independent filmmaker to do that. And so Coppola inspires not just Lucas, he inspires Steven Spielberg too.
Coppola actually succeeded in getting his hand on the door knob and flinging open the door. And suddenly, there was a crack of light. And you could see that one of us, a film student, without any connections had put one foot in front of the other and actually made the transition from being a film student to being somebody who made a feature film sponsored by one of the studios.
To Steven Spielberg, Coppola was a shining star. Spielberg said, Francis was the first inspiration to a lot of young filmmakers because he broke through before many others. So not only did Coppola proved to Spielberg and Lucas that, “Hey, this is possible.”
But the influence that Coppola had on Lucas too is like, “Listen, you have to learn to write.” At this time, and you’ll see Lucas make this mistake a few times. He tries to outsource the writing. And Coppola was saying, “Hey, what separates just a director to a filmmaker is like you have to — any director, he would tell Lucas like any great director has to know how to put together a screenplay. And so he would repeat to Lucas over and over again like no one’s going to take you seriously unless you write. And that wind up being excellent advice because Lucas forced himself to write Star Wars, which is obviously his entire empire.
I’d be working all day and all night living on chocolate bars and coffee, said Lucas. It was a great life. I had enthusiasm, and I was too busy to get into drugs. Movies where his addiction, we were passionate about movies. “We were always scrambling to get our next fix.” Listen to how they’re describing this. This is how he knew what he’s been doing with their life. Described working as your next fix to get a little film in the camera and shoot something.
Spielberg has said multiple times that George Lucas inspired him and said at the time of his first encounter with Lucas in early 1968, Spielberg’s filmmaking was still more aspiring than actual. And Spielberg talked about this, like no longer did his role models have to be these older, in many cases, deceased filmmakers. They’re actually someone his own age, someone I can actually get to know, compete with and draw inspiration from.
“Surf the wave when it comes”
The next year, the film Easy Rider comes out. It is written and directed by a 32-year-old or a 33-year-old Dennis Hopper. It was not made in Hollywood. It was made on a shoestring budget. They raised $350,000. Why is that important? $350,000 is released in theaters. The film makes $60 million. Easy Rider goes on to be one of the most profitable films ever made.
And so the studio executives see them and they’re like, “Oh, s***”, and this is what they said. The studio smelled money. Why invest millions bank rolling production of an enormous film on a studio backlot when you can simply distribute independently produced films. Suddenly, independent films and independent filmmakers, which is exactly what Lucas and Coppola want to be, were in demand. The studio wanted young talent.
I just said that Charlie Munger talks about surfing the wave.
Listen to the words that they use to describe this.
Easy Rider had created a tsunami of independent enthusiasm. Coppola decided to ride the wave right into the offices of Warner Bros. Come on, that fit together so perfectly there. So goes with Warner Bros.
This is Coppola who’s like — sometimes I think you might need a guy like this because it’s not like we’re going to make one movie.
He is like, listen, you front us a bunch of money. We’re going to bring you a finished film just like Easy Rider did. We’re not going to do with this once. We’re going to — we have seven films we want to make with you guys. We have seven films we want to make with you guys.
They’re young entrepreneurs, don’t have experience, don’t really know what they’re doing. The movies they’re going to make are going to flop. But what’s fascinating is like they still had an insight into the future. And so it says both Coppola and Lucas predicted a bold high-tech future.Remember, this is 1969, 1970, maybe. And they said movies will eventually be sold like soup. What does that mean? You’ll be able to buy it in cartridges for $3 and play it as you would a record, music record at home. He’s predicting VHS tapes, then DVDs, then Blu-ray and now streaming.
Forgiveness not permission
This is more juvenile delinquent behavior. He says the rules are of no concern to him. I broke them all. He said, “Whenever I broke the rules, I made a good film”, so there wasn’t much that the faculty could do about it.
George Lucas is very resourceful. He always would find a way to get what he needed in terms of equipment and bodies to put together a crew like sometimes when you film like when you film Star Wars in London later on, they have these like really strict rules for the London like Film Union. You have to start at 8:30. There has to be a tea and I’m not even joking about this. You have to start 8:30, then you have to break for tea at 10 a.m., and then you have to break for an hour lunch at 1:00 and then you need another tea break at 4:00 and then you can’t work past 6. He’s like this is madness.
He didn’t want any kind of restrictions. So they would break into the equipment room to get not only materials that they needed, like an expensive camera, but they would also break into facilities. It says Lucas didn’t want to limit his use of the equipment to the building’s regular hours either. We’d shimmy up the drain spout, cross over the roof, jump into the patio and break into the editing rooms so we could work all weekend. And this idea that you use juvenile delinquent actions to actually be more productive.
Entrepreneurship is problem-solving
Tarantino in his book, he says, the job of a director is to solve problems. Solve problems for your actors. And I read this book by Danny Meyer, the famous restaurateur called Setting the Table. It’s excellent. And he tells a story that I’ve never forgotten. He’s at dinner with Stanley Marcus, who is part of the Neiman Marcus family, the family that controls the Neiman Marcus. He’s a wiser older man, probably, I would guess, 40 years older than Danny at this point. I think Danny’s in like mid-20s, maybe late 20s at this point. And so he’s — they’re having this conversation:
Danny says:
“Opening this new restaurant might be the worst mistake I’ve ever made.”
Stanley set his martini down, look me in the eye and said, so you made a mistake. You need to understand something important and listen to me carefully. The road to success is paved with mistakes well handled. His words remain with me throughout the night. I repeated them over and over to myself and it led to a turning point in the way I approached my business.
Stanley’s a lesson reminded me of something that my grandfather had always told me. He said the definition of business is problems. His philosophy came down to a simple fact of business. Success lies not in the elimination of problems, but in the art of creative, profitable problem solving. The best companies are those that distinguish themselves by solving problems most effectively.
The way I condense that down so I can remember myself, business is problems. Therefore, the best companies are just effective problem-solving machines. The best directors are just effective problem-solving machines.
Lucas has a problem. He’s got an idea in his head. No one can make the special effects. There’s no technology at the time. So what did he do? The solution sometimes to a problem is to found your own company to solve that problem. The solution to this problem that he’s having now is the founding of Industrial Light & Magic.
So it says Lucas would not merely have to produce the visual effects. He would have to develop the technology needed to shoot them in the first place. George was absolutely adamant that he wanted to set up his own shop with his own people. Industrial Light & Magic would then be an official subsidiary of Lucasfilm, born of necessity seeded with his own money and feeding off Lucas’ need to control every aspect of the production.
Industrial Light & Magic would stand as one of the cornerstones of Lucasfilm’s empire, an investment that would set him well on the way to becoming a multibillionaire.
Ron Howard admiringly said:
How many people think of the solution of gaining quality control, improving fiscal responsibility, and stimulating technological innovation is to start their own special effects company.
