1/ Quick mini-thread on a useful way to think about risk based on a recent discussion I had.

"If I have an opinion about lithium price, should I trade $LIT?"
2/ Almost definitely not. $LIT is a very weird monster. Many ETFs that target second-tier commodities are equally weird. Why?

Because $LIT includes both producers and consumers.
3/ High Li prices are good for producers, bad for consumers. So what's the effect on $LIT?

It depends on the balance of producers and consumers.
4/ 12% $ALB. They produce Li chemicals for batteries. Producer or consumer? Not clear.

5.9% Ganfeng Lithium. Producer.

4.7% $TSLA. Consumer.

Etc. It's very confusing.
5/ So let's develop a general model for resource stocks.

We can think of a resource stock as an arbitrageur. They arb the price of their inputs against their outputs.

This is true of business in general, but it's an especially useful model for resources.
6/ A gold miner arbitrages the price of gold with the cost of extracting it from the ground.
7/ A refiner is even more clearly an arbitrageur. They transform oil into gasoline (and other refined products).

If they can make that transformation more cheaply than the crack spread (gas - oil) they make money. Else they don't.
- Airlines arbitrage kerosene into seat-miles.
- Farmers transform gasoline into soft commodities.
- Food companies transform soft commodities into consumer food. Etc.
9/ Want to put on a trade in lithium? You need to answer the question:

What systematic mispricing in either the:

- inputs (the cost of mining) OR
- the outputs (the price of lithium)

have you identified?
10/ If it's the output then you're better off just trading the commodity.

If it's the difference between the inputs and the outputs then you should think about trading the company's stock.

Or get into the business yourself!


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More from @AgustinLebron3

22 Feb
1/ Taking a break from options to talk about a general trading concept.

Intended audience: people who are getting into trading, people have read a bunch of “experts” and came away even more confused, etc.

A thread…
2/ I thought about putting this in the book, but in the end I decided it’s too technical for a general audience. The one sentence claim I make here is:

“Trading is the wrong term for what trading is. Trading is more accurately called positioning.”
3/ What do I mean by this?

Retail traders seem to obsess about “entries” and “exits”. But in my career as a trader, I *never thought about entries and exits. At least, not explicitly.
Read 34 tweets
8 Feb
1/ Welcome to Options 201! You might remember me from such threads as Options 101:

Or What’s The Deal With Having Edge?

2/ I wasn’t sure if I should keep going. We’re getting closer to “how to make money in options,” and I think public sources of such claims are always and invariably scams.

But I’ve decided this is still more “useful information to know” than trading edge, so it should be ok.
3/ Let’s start by talking about time. Time is surprisingly hard to think about. But why do we care?

Well, as we said in Options 101, we want to convert our options prices into vols because of #reasons. And to do so, you need to know t_exp.
Read 62 tweets
30 Jan
More ruminations on what trading can teach us about non-trading things. A thread...
Recently reading @SinclairEuan's excellent "Positional Option Trading", and he reminded me of something I hadn't thought about for a while:

Great trades start with a known risk premium and then add idiosyncratic inefficiencies on top to get more alpha.
The risk premium is a long-term thing. The vol premium or the carry trade aren't going anywhere.

But you can't really build a business on them alone. Too many people know about it, so returns are at best "ok" (i.e. low Sharpe) but with terrible tail behavior under stress.
Read 14 tweets
4 Jan
1/ Options 101 (a thread):

When you teach options, they put you in jail if you don't start with this:

A call/put is the right (but not the obligation) to buy/sell a security for a given price at (or by) a certain time. Boring! Let's do an example:
2/ If I own the Mar 700 call in $TSLA then that means anytime before ~5pm on Mar 19 2021, I can exercise my right to buy TSLA shares.

I hand over $700/share and I get some TSLA stock. First let's note a few things:
3/ US equity multipliers are typically 100 (barring corporate actions). So when you buy 1 options contract (call or put), you're actually buying the right to 100 shares.

Remind me to tell you the story of when I messed up the DAX multiplier. I was *sure* was going to get fired.
Read 56 tweets
23 Dec 20
Many different-seeming activities have a very similar characteristic when you compare skilled people to world-class people:

Almost all of the difference can be explained by the quality of left tail performance.

1. In golf, @LouStagner and @scottfawcett have shown that scratch player vs professional "good shots" are fairly similar (within a few %), but the bad shots are sometimes 2x worse for scratch players vs pros.

And scratch players are really good at golf.
2. In chess, a big part of your ELO is how often and big your blunders are. The difference between an IM and world-class GM isn't that @GMHikaru finds brilliancies much more often, it's that his worst plays are still really good.

Arguably this is how @MagnusCarlsen wins so much.
Read 6 tweets
25 Jul 20
Had a long think about things @KrisAbdelmessih and @VitruviusCurve wrote this week. About ML in trading.

The levels of quant trading:

0. Fumbling around in the dark.

Most people stay here forever, and even those who progress past this level still revert to it with annoying frequency. :)
1. Does +EV trades.

Has figured some things out, can do good trades and know they're good in expectation. This is a hard level to get to!
Read 7 tweets

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