You flip a single die and will paid $1 times the number that comes up. How much would you pay to play?
Suppose I let you take a mulligan on the roll. Now how much would you pay (you are pricing an option now btw)?
My batting avg is higher than yours for the first half of the season. It's also higher than your for the second half of the season.
Is it possible your avg for the full season is higher than mine?
(Simpsons paradox)
You are mid game that you have a wager on. Opponent offers to double the stakes or you automatically lose. (like the doubling cube in backgammon)
What's the min probability of winning you need to continue playing?
Your down by 2 with seconds left in regulation and have a 50/50 chance of winning a game. You have a 50% 2-pt shooter and a 33% 3-pt shooter.
Who do you give the ball to?
(simple EV question)
You are given $1,000,000 for free but theres a catch. You must put all of it into play on roulette.
What do you do?
There's a 30% chance of raining Saturday.
30% chance of raining Sunday.
What's the probability it rains at least one day?
Some risk tolerance stuff...would you bet $100 on a fair coin if you got 6-5 odds? How about $1,000?
(Just trying to see if you understand how bet sizing/edge/bankroll work. Kelly answer would have been the A+ version, but really was looking to demonstrate that you were sane)
Let's actually understand the meaning of vol drag.
This week I explained that while meme stock put spreads "look" expensive, there's a good explanation.
High vol affects the skewness of a distribution -- it shifts the median return lower...
But the thread I wrote bounced all around the internet but like a nerdy game of telephone the message is suffering from major info loss as it gets passed on.
What you need to remember:
Vol drag does NOT change the mean or expected return. It affects the return you are most likely to experience.
Gonna put JS index expiry manipulation aside. It looks bad and if that was their intent it is bad.
But regarding the strategy where they sloppily buy deltas to turn around and sell option combos at artificially pumped prices...
The antitode is for the losers is to
realize that they aren't entitled to overestimate how much liquidity “last sale" represents
I mean as a market maker you are taught not to provide more delta liquidity in the options than the underlying so this isn't some profound suggestion
For example, if a market makers is seeing a bid for puts or call offers they are pricing the vol using the stock's bid (and vice versa, they use the offer if the option order is buying delta)
But they don't assume infinite liquidity at the bid or offer
moontower today was triggered by an insightful comment by @ScottPh77711570 on @choffstein podcast
Excerpts...
I fired up Corey Hoffstein’s goated Flirting With Models podcast to hear Scott Phillips discuss “ugly” edges in crypto. This episode came highly recommended in my corner of twitter. It does not disappoint.
But I want to zoom in on one part. Scott says:
I’m repetitive on log and compounding math for 2 reasons that extend beyond the shock factor of the “lilypads in a pond” puzzle:
a) Investing is a serially repeated game so compound returns are our primary concern
I haven't actually done this explicitly but I could imagine some model where you solve for how many negative carry days vs speed to revert to say some vol target and set the p/l path to zero to solve for how long the market thinks it will take to resolve to a normal vrp world
It's not a real model, too many cross influences between the paths, but just framing it like this sharpens your thinking. Fuzzy "it'll go down eventually" is probably so consensus that my guess if I knew nothing else the vol is underpriced
If they ban short-selling derivatives become the underlying
A reminder in the spirit of being attuned to seemingly far-fetched risks:
If short selling were restricted in any way, the value of puts relative to calls on the same strike increases in a put-call parity framework.
Another way to say this is being long stock is more valuable since only long sellers can sell. If puts increase relative to calls on the same strike, as they do when borrow costs increase, that is like a synthetic future on the stock trading at a discount to the stock price.
A little thread of fun intuition for option probability based on yesterday's letter
A couple weeks ago @dampedspring posted:
By saying I’d buy that proposition I’m saying “I’d buy that vol”
Andy, responded with a joke about what’s the “one touch” option worth, which I asked him to delete because I really would have liked a fool to sell me that proposition and Andy’s comment gives away the sauce.
[X’s killer app would be to escrow bets, but that’s another convo altogether]
I’d be a size buyer of a 50% probability that we get back to the highs before the end of the year.