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Do I have to be a math whiz to trade options?

I love trading options. But if you haven't tried them, maybe it's because it all sounds so complicated. "Delta," "theta," "gamma," blah, blah. Yeah, the Greeks might be fine and all, but one doesn't necessarily feel like a natural quant-type, and it's all rather confusing.

Here's a secret. you don't actually have to do the math to develop a sense of how options work or how to suss out where things ought to be and are likely to go.

For example, suppose you’re interested in NOW opts for next week. The stock is down 10 points or so today, by the way. Here’s an options chain via barchart.com. Suppose you bought a call near the money at $410. Suppose the stock goes back to $420 tomorrow.

What will the call be worth? Well, you could eyeball it by looking at today’s price on the $400-strike call. The $410 call fetches about $6 more than the $400. So, if the stock moves up $10 tomorrow, then tomorrow’s $410 call might be about $6 higher than today's. And so on. Remember that time decay will change things fast, so this back-of-the-envelope comparison will only work in the very short term. For an idea of what time decay (aka "theta") will do, look out a week or two or three and compare the same strike price to the one expiring this week.■

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Green investing and party poopers

People tout "good" stocks to me because they believe in what the company stands for: its goal, or maybe its dream. But if all they mean is that it's is the right stock to buy because of the social good the company has set out to do (or purports to have set out to do), then I think they're turning stock trading into wearing one's heart on your sleeve, as it were. I have nothing against ethical or "green" investing. The trouble is, though, that it tends to put the cart before the horse: the wanna-be-ethical choice degrades into empty virtue-signaling. What if the company has problems, be it hidden or overt? What if it's dramatically overpriced because of the similar emotional response of other investors? What if it's morally a feel-good thing but economically a lead balloon? What if it's hyped years or even decades ahead of its likely actual performance promise? Worst of all, what if it's really just a charade?

If, because it seems implausible, you don't buy the dream that's being pumped, does that make you an ogre?

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"Whoops, I was wrong."

There are two ways to be wrong. One is to be wrong because a rare chain of events transpired that you could never, in all fairness, have anticipated.

The other is to be wrong because you are ill-prepared for easily foreseeable events. You take needless risks.

Needless to say, the first way is much better. And since everybody, without exception, is wrong a good deal of the time, the true further test is how you planned for the eventuality. What was your escape hatch? Did you have one?

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Swagger

Whatever the things are that make stocks go up or down, machismo is not one of those things. Your posturing and virile fintwit swaggering and strutting says a lot about you, but essentially nothing about what your favorite stock is going to do.

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Anomalies and distortions aren't strategies; don't reinvent the wheel

Saying that meme stocks disprove tried-and-true wisdom about investing is like saying that the surge in homelessness on our cities' streets disproves the value of reasonable planning for job security or home ownership.

There's still value to the moral of "Three Little Pigs." Building your house out of brick is still a better plan than building it from hay.

That the tale is 130 years old doesn't make the advice wrong. It's specious to disclaim any and all historical observations about how the world works merely because your generation didn't think them up sui generis.

Stocks can go up deservedly. Stocks can go up undeservedly. (The reverse of two statements is also true.) Which stocks do you want to spend your time and wealth accumulating? Which ones do you want to spend your energy posting about on social media and trying to shake profits from? Which ones do you want in your eight-to-eighty portfolio?

Buying lottery tickets is not a viable plan for your financial future.

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On blow-ups and bankruptcies

Hedges are good as long as there is a garden to support them. If the garden burns up, the hedge is just extra tinder.

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Long and short are symbiotes

Stop viewing the bull-bear dialectic antagonistically and come to understand that it's a mutually supportive relationship, a symbiosis, the eternal Ying vs Yang.

A bearish view is not "the Dark Side" and it's not definitionally evil. The bull argument, similarly, is not "the Force" and it's not definitionally good. They are outside of an ethos or morality. They aren't even poles, since the extreme endpoints are as rare as the endpoints on an infinite number line.

The idea that this is some great, Middle Earth battle for the Grail or for Eternal Damnation is not just a fairy tale, it's a farce. It's nonsense. It's cargo-cult mentality (look that up!). Both sides can win. Both sides can lose. Or one or the other, respectively. There's no zero-sum game here; it doesn't fit the definition.

We're all human. We all deserve respect, and an ear. People must lose the feckless sophistry about how the streams and eddies of financial markets work.

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Tommy

Did you ever play pinball? Who here remembers pinball?

Did you ever listen to the words to "Pinball Wizard" from the Who's Tommy rock-opera?

Well, I'm not deaf or dumb, nor am I a savant. I have been known to tilt the machine from time to time. (Blow up my account, I mean.) But what I do know is, when the silver ball is coming down through the bumpers, you can see its trajectory. You can plan for it! You can ready your fingers and your reaction impulse on the flipper buttons, the way a cat uses its whiskers to help it prepare for delicate change and danger in its environment.

You know how hard you're going to press the flipper. You know where you expect — let's leave out "want" from this — the ball to go and how likely it is to do so if you flip it right.

That's how you know where to set your orders. What is the trajectory? What is its potential energy? Its kinetic energy? Moment of inertia? What outside factors are at play? This is the same thing. Expect the possible and the plausible. Buy. Sell.⬕

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What's the big deal about 32¢?

I traded premarket and made a fast 32¢ scalp. It was a tiny, 100-share trade. I kept $32. Big deal, says cynical you, right? And I'm not posting about it for the brag. (I've got bigger things to do today.) But hold on.

Do you know how many trading days there are in a year? Two hundred fifty-one, give or take. What if you made your diddling around in the markets more efficient so that you took in an extra $20 a day — that's all; no sky-high dreams, just $20 — on average every trading day? Without much extra risk or skin off your nose, I mean. Without disturbing your Master Plan. Well, that's an extra $5000 in your pocket without much effort at all.

If you improve your performance even just 1-2%, it makes a tremendous difference to your results. Find out where you can add efficiency and improve productivity in your daily routine. It's a lesson for life in general, not just trading.

Thinking about, and working through, efficiency should be your watchword in trading and in life.⬕

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What role does time have in managing risk?

You should always be paying attention to your potential downside. Yes, I know, it's an unpleasant idea. It's more fun to dream about the upside. But let's be real. Ninety percent of traders lose money. Many of 'em lose a lot of money.

That's not meant to be scary, it's meant to be a reality check. You don't have to succumb. But it takes intelligent planning.

All the usual watchwords to guarding the henhouse apply. These include knowing your exits ahead of time and nipping losers in the bud. Dump 'em. These are basic rules.

But what about time? Well, think of a burning candle. The flame is hot. It can start a conflagration. It can burn your house down! Yet, you can move your finger through it at a leisurely speed without pain or danger. Why? Because exposure time, not just intensity, delineates danger and risk. How hot is your stovetop? How long do you heat the pot?⬕

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125th anniversary of the Dow Jones Industrial Average

125 years ago, on May 26th, 1896, the Dow Jones Industrial Average (DJIA) was first listed on the NYSE. The first Index ticker was priced at $40.94. The seminal index was conceived by the founding editors of the Wall Street Journal and financiers Charles Dow and Edward Jones of the brokerage house Dow Jones. It remains the preeminent index 'round the world.

The Index comprised 12 large-cap stocks listed on the NYSE. Today it holds 30. After GE's removal in 2018, none of the original components of the DJIA remained listed on the Index.

The Index plunged 22.6% on Black Monday, October 19th, 1987 [I was there watching, jaw agape!]. It remains the steepest one-day plummet ever for the Index. From the open at 2,247, it fell through the following day to a low of 1,450: the first earnest market crash since WWII in the Western industrial countries.⬕

Photo: New York Stock Exchange, 1882, by American illustrator and scenic artist Hughson Hawley (1850-1936). Source: Wikimedia Commons

[This historical Précis was inspired by an entry in the Harenberg Chronik page-a-day calendar (German).]

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On the hunt for trading vehicles

Here's what I look for when I want to add a ticker to my swing-trade regulars.

The preface is, I’m not always looking for new tickers. I do so when extra cash is at hand. Still, I keep the size laughably small until I get a feel for the stock. Trading new ideas is fraught with danger. The stocks I follow and scale into and out of over months or years – where the zero on the shares-held number-line is just an orientation spot in the middle of the journey – have proven themselves manageable with my method. I get to know their fundamentals, but more importantly still, how they move.

So, how do they move? Is your stock a house sparrow or a swift? Sparrows fly only short distances. Their peregrinations are limited to within a few miles of where they hatched. Swifts, in contrast, spend their lives in the air, living on the insects caught in flight; they drink, feed, and often mate and sleep on the wing. Some individuals go 10 months without landing. No other bird spends as much of its life in flight.

But okay, if I want to look for things to go short in, which is what most interests me in my trading account (but not my retirement account), I want essentially the opposite of things you’d look for to invest long in.

I look for lousy financials, earnings misses, sagging revenues, a toppy or already declining chart, indicators (Bollingers, MACD, volume smokestacks, etc.) that are in line with cyclical choppiness and going my way now, and so on. This has little or nothing to do with the social utility or mission of the company. I’m not running for the company's board; I’m trading a financial instrument nominally tied to its identity. “Good product” does not necessarily mean “good stock”!

But most important for me, I want the ticker to trade options. I use both the stock and options, weighting and unweighting each on a running basis. I use the options to pull on the stock in the direction I want to go, almost always selling premium to take advantage of theta (time decay).

If the stock is a darling on the boards, I use spreads so I don’t get murdered. If I know the stock well and it seems unlikely to spike like a banshee, I might sell just a few naked OTM options.

If the share price is unlikely to leave its recent peregrinations or if I have too much short-call exposure, I sell OTM puts spreads, too. How wide depends on objective risk, size, my certitude, my liquidity, etc. I am willing to take assignment!

I prefer stocks with weekly options, but I’ll take monthlies. I look for good implied volatility (IV), useful prices ($5 calls on a $1.50 stock are not useful), etc. I look briefly at open interest, Greeks, bid-ask spreads, etc., but I don’t pay undue homage here. I bait my hook (set my limit orders) and I wait for a bite. I do flick my line sometimes.

I want the spreads to pay. I don’t trade GME spreads now, as one example, since if you go up $30 on the price ladder, you’re only going to make 30¢ or something. That’s far too much inherent risk for little reward. The trade’s EV (expected value) says to leave it alone.

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The Flight of the Bumblebee

"What's your ultimate target on this?"

Someone asked me that on Stocktwits today.

I'm a bit flummoxed by the question, because to me it's like asking what the ultimate resting point is for a bumblebee. Well, it has a nest, I guess, and companies and markets have either dissolution (through bankruptcy or otherwise) or, eventually, the death of financial systems ahead of them at some unknown, far-off future point in time. So there's that. But that's not what he meant, I gather.

While the bumblebee is flying, or bumbling, around, I try to see where the edges of its current usual routes are and place my orders there (ahead of time). These can be daily, weekly, or longer-term. I have open orders for all these scenarios. It's like tracking the surmised oblong erratic orbit of an uncharted asteroid. The future hasn't happened, after all. But we know what sorts of moves are usual (cf. True Range, Pivot Points, price stickiness, etc.). The idea is to profit from all these things, not just to augur some final powerful predictive endpoint far in the future.

I want to make money from the process, not just the landing point for Ice Station Zebra (which I have no way of knowing). I know things with far more certainty that are nearby; e.g., I know approximately what tomorrow's weather will be like, but the further out I go, the less I know. I don't know the weather for next November 8th (six months hence as I write this), although I do know what historical averages and maximum ranges have been. So there's that.

A stock makes me money because of how it moves. It's the way an erotic dancer makes the club owner money because of how she moves. But I don't know, or care, where her apartment is when she goes home at 2 AM.

[DR: I showed him a six-month chart.] There are things we can guess the way we can guess at the weather six months from now. See? I've marked some stuff. I've offered a good plausible bet. But that's no guarantee!

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When labels become traps

People are often itching to know if I'm long or short some position.

There isn't always a yes-or-no answer. My positions are complex. Options get layered on both sides in short-long-short stripes in attempts to cancel out in-extremis risk.

Short options are oversubscribed to gain from time decay. Long options above or below are a final safety net. These long options typically lose; short ones typically win. I accept some assignment when options go in-the-money. I then rebalance with covered option writes (i.e., sold short but backed by an opposite weight in the underlying stock) or spreads that push back in the direction I want to go.

When bubbles get followed by fast downdrafts, various short puts can assign. Last month, such assignment took me long in several stocks I wanted to be short in. For most, I end up winning anyway, because covered options and trading it out overtake the stock drawdown. It balances decently. But it's a process. It can take some time.

One month's loser can be an overall winner. It works like a Ferris wheel or a paternoster lift. The static picture is only part of the story.

"Long" or "short" are abstract ideas to me. It's like asking if it's raining or sunny out. Yes, at this moment it's one or the other, or maybe it's partly cloudy or there are intermittent showers. It probably won't stay that way long-term. The positioning and balancing are tools or equipment: an umbrella, a bottle of sunscreen, a light windbreaker, and so on. The options are more nuanced tools to add leverage or support or to counterbalance.

If you have a household budget, you might allow yourself to overdraw for short periods for unusual expenses. They might be nonrecurring or intermittent burdens. Maybe your car broke down or you need a new refrigerator. A snapshot of that moment doesn't mean much. And you use the repaired car to improve cash flow further soon thereafter.

In summary, "long" or "short" are conceptual (uh) shortcuts that leave too much unstated. One hundred share short is not the mirror image of a thousand shares long. And you can be out on the bay sailing on a beautiful day and still have a need for a light windbreaker. You can change, and protect for, your level of exposure.

People get too wrapped up in nomenclature that is often misleading or less than useful. When they react emotionally to the labels they apply to target you as a bosom buddy or a mortal enemy because of that one word, it's specious nonsense.

A cosine wave ("short") is really just a time-shifted sine wave ("long"), right?

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Trupanion earnings call nonsense

From the $TRUP earnings call or, should I say, "chum-up puff piece," comes an essentially potshot selection of verbiage out of the transcript from Tricia Plouf, CFO. This is a good example of why earnings calls, which so many wait eagerly for and hang on every word of as if they're listing to a "Prairie Home Companion" weekly radio show in order to glean meaning from their own small lives, are essentially worthless:

"As a percentage of subscription revenue, the cost of paying veterinary invoices for our subscription business was 72%, and variable expenses increased slightly to 10%, both reflecting continued investment in people, systems and claims automation capabilities to reduce future frictional costs and deliver a more differentiated member experience. We will continue to invest in these areas in the short to midterm, so long as we continue to see future benefit."

Translation: we lost a bleeping lot of money, but, see, we're grooming our transactional partners, so it's OK!"

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Open letter to a Twitter follower

Someone I’ll describe as a casual follower on Twitter wrote me the following. The rest of this post is my response.

Thanks for the ping.

First of all, let me clarify that I don’t advise people to buy or sell any stock. As it says in my profile and has said for a decade, “please don't blindly follow trades; do [your own] due diligence.” I have ongoing open discussions with a few Tesla bulls. I state my opinions and they state theirs. So, that’s all about that part.

It isn’t rhetorically or logically defensible to judge the underlying correctness of someone’s views about an investment choice based on an ex-post-facto review of where the stock went. I believe you understand that statement and its connotations implicitly, given that you have a Ph.D. in physics. If I don’t buy lottery tickets because I think they have a bad expected value financially – and this is, indeed, what I think about that – and if I suggest to others they might want to question their desire to buy lottery tickets, well, don’t come to me with accusations when the ticket you didn’t buy because of me ended up being the winner.

People are, indeed, influenced by what other people say. People who present as reasonable and thoughtful can carry a certain weight with interlocutors. If ‘X’ is opposite to and incompatible with ‘Y’ and I think ‘X’, I am necessarily arguing against ‘Y’. I can do so quietly or vociferously; I can condemn ‘Y’ if I feel strongly enough about it to want to do that, or I can just keep to my own business and say very little. Deciding what the ethical burdens are for people’s stating their views and debating a position is the devil’s work.

But ultimately, we’re all adults, or should at least be presumed to be such under the (usually) polite social fiction of individuals engaged in discourse and in defending a viewpoint.

My dad spent his formative teenage years under the shadow of the Great Depression. He had always wanted to be an engineer. When he was about 18 and times were tough, a door-to-door salesman came by and tried to sell the family a refrigerator. This would have been about 1933. My dad engaged the fellow in conversation and learned that he was an engineer, but out of work because of the economic slump. My dad thought hard about that and decided he’d prefer an occupation less susceptible to the vagaries of the economy. And so it was that after college he went to medical school. He became a surgeon. In any case, lives can take a different course because of something somebody said.

ii.

(Click here for Chart source.)

Now let’s get down to the nitty-gritty: I believe Tesla is operating under a veneer of legitimacy but is hiding a core built on deception and deceit. I’m not alone in thinking this. I may be a smart investor or I may be a fool, but various notable, wealthy traders of renown share the view. Various other people whose opinions I’ve studied and who I’ve decided are savvy in their appraisal of technology and accounting share the view.

Might we be wrong? Of course. That’s the whole point of questioning oneself and one’s choices as a, if I may borrow a meme while simultaneously noting the irony of doing so, first principle. It’s what we historically referred to as a dialectic.

The stock is not the car. The company is not the car. I have admired the car publicly. (I’m not addressing quality or service issues here.) I have two relatives who own Tesla Model S vehicles. My cousin Dave bought his after reading a blog article I wrote about the unusual camaraderie of Tesla owners I interviewed at a charging station near my home. He loves the car. He didn’t listen to the part where I told him I wouldn’t buy one.

I have also acknowledged variously over years some of the admirable things Musk has accomplished. Changing the direction of the automobile’s development and ultimate impact on Planet Earth was an astonishing thing. But he has long since lost his moral compass. The ends don’t justify the means. A leader who abuses people under him and misleads is not someone I can ultimately judge approvingly. A CEO who has built a latticework of lies and misstatements to prop his endeavors is not someone I can ultimately judge approvingly.

To me, what Tesla’s share price has done is inexplicable in a rational analysis. It may cost me money sometimes, but I do prefer to try to analyze opportunities rationally. I am also constantly questioning my own motives and decisions. It is a foolish trader who claims to have unwavering certainty. It is a foolish citizen who claims his certainty is intellectually superior to the inquisitive person’s skepticism or doubt or hesitation.

Stocks move in spurts based on fear and exuberance. Sometimes the exuberance grows – how can I put this – extreme. Yet there is always an underlying company. We can and, in my view, we should look hard at how well it is operating. We should note that stock prices often move irrationally over long periods of time, but that this does not prove (or disprove) the validity of a thesis that touted that irrational direction.

I can cite various famous cases of stocks that went up tenfold, 25 times, even 100 times or more and ended up collapsing in a dust cloud of fraud. Is Tesla one of those? I think it is. I might be wrong. It’s your choice as to what to believe or whether to give credence to my thesis.

If you want to trade on irrational exuberance – and many, many traders do, including some whom I debate frequently – well, be my guest. Many have indeed gotten rich that way. And many others have landed in the poor house. In any case, it’s not what I’m interested in doing with my trading or investing.

Moreover, the bull thesis was crushed brutally near the end of the second quarter of 2019 (look at the chart above). Countless investors certainly bailed with huge losses. The falling knife or the flying missile cuts both ways.

Innovation is not equivalent to, nor does it supplant, profit. Dean Kamen’s electric two-wheel self-balancing Segway transporter was mind-bendingly brilliant and exciting technology when it was introduced going on twenty years ago, yet the manufacturing company languished financially for years and ultimately shuttered its doors last month.

I’m limiting myself now to discussing some of my reasons why I think I can defend my views about Tesla despite the stock’s unprecedented rise and ride on the coattails of exuberance and dreams. I do not wish I had bought the stock. I made lots of money shorting the stock over five years until last summer. I’ve lost money in it since then. But my success or my failure at trading is not the yardstick here.

I have a collection of blog articles here crafted in the general direction of this discussion. You might find them worth a look. Or you might decide to stop interacting with me. Your choice, of course.

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What is analysis?

Real analysis looks at data objectively, constructs a thesis that the data ostensibly supports, and suggests predictive outcomes from that model.

Too many turn the process on its head. They come to the party with an expectation for a stock based on a subjective emotional response. They then cherry-pick data that seems to support their "thesis." That's not analysis, it's finding a pattern to fit a presumption. It's a circular argument in which the conclusion is included in the premise. It's the original, rhetorical-fallacy definition of begging the question. And it's confirmation bias.

In any case, it doesn't objectively help anyone to assess the true quality of an investment.