Indifference and Unknowability

Following StockTwits, Twitter, Facebook, CNBC and the rest of news, it seems the two main questions are:

• Will this stock (or other asset) go up or down? 
• Will the market go up or down?

With my options trading, my views are:

• I do not know
  • In fact, no one knows over the long term, whether it’s a market guru, television personality, a well-credentialed portfolio manager, a well-pedigreed executive, and so on.
• I cannot know
  • Even the large powerful Wall Street banks and hedge funds are never correct much more than 50% of the time, and often are worse than random
• I do not care
  • Options provide the ability to bet with a Bullish, Bearish, or Neutral orientation, and because capital can be extracted from any of these security or market states, I only care that I execute the correct trade for each scenario
• I should not care
  • This is just a statistics game. Nothing more, nothing less. I’m not staking myself on any one company, market, or trade.

My strategy provides the ability to make money so long as there are no fast and massive moves. And if there are fast and massive moves, I only lose a little (1% target, with 5% absolute max) in any single position since I keep each position small and risk-defined. Have a plan, execute on it as mechanically and unemotionally as possible

That’s my trading philosophy. It’s truly exciting and liberating to have a strategy that relies on consistency and persistency, and has almost nothing to do with any particular state of an asset or market.

SELL of 100 XXII Calls Expiring January 18, 2019

Sold 100 January 18, 2019 Calls as the exit strategy for my entire 10k shares of $XXII for a net credit of $6k, as I wrote about in the two most recent blog posts. This is effectively a super Limit Sell order on $XXII where I get paid up front for waiting.

• 80 Calls at $5 strike
• 20 Calls at $4 strike

Net credit of $6k for selling 100 January 18, 2019 Covered Calls

Also doing well on a few other options positions I opened up last week. A bit obsessive always pondering what the implications of the daily Theta time decay on all these current options, which now is more than the daily rate I pay for my physical apartment!

The plan is to scale this up to 30 positions within 2 weeks, and add at a rate of 2-4 more total contracts per week while rotating positions on/off, each position requiring about $500 margin collateral. Will deposit from a portion of my biweekly paycheck for margin collateral instead of to my 401k, where I feed the blood-sucking parasites in the financial industry that get paid 1% of my portfolio for doing what a dull trained monkey can do.

The overall plan is by July 1, 2018 to always have at a minimum 100 total contracts (distinctly from the 100 $XXII contracts secured by my shares). Those 100 contracts aren’t particular ones, but are the aggregate at any one time, rotating on/off as they’re opened and closed by my trading program and dependent on new high Implied Volatility set ups or earnings trades. I estimate they can each generate on average $50/month.

By December 31, 2018 of next year, I want to have a minimum of 200 contracts working at any one time.

Feeler Sell of 10 January 18, 2019 Calls for $XXII

To follow up on my post a few hours ago. Decided to throw out a feeler SELL of a 10-contract $4 strike CALL for January 18, 2019. Some details. Writing it all out mainly to articulate to myself what’s happening, to see where I can optimize for better trades in the future.

Trade confirmation of Sale of $XXII $4 Calls expiring in January 18, 2019

– Execution
Spread was Bid ($0.70) x Ask ($1.00) per contract. I was able to get executed at $0.80 right near the midpoint. This means that for each contract, I just took in a credit of $80, for a total of $800 (which happens to be 1 month of rent, haha).

Optimization: for future sales, will want to move the Limit order away from the Midpoint closer to the Ask price for a higher price.

– Commission Rebate
What’s very interesting are the negative transaction costs. It means I got a rebate from the exchanges that made negative my total all-in transaction costs including commission, so I actually got paid to make the trade. This happened since I was “providing” liquidity to the market, via selling above the market Bid price, instead of right at it. If I were to hit the Bid, I would’ve had to pay about $17-$20 in total transaction costs, since it works out to about $1.70-$2.00 per contract including all applicable commission and fees.

Optimization: ALWAYS try to get the rebate. Easy for these simpler options sales, but a bit more difficult for the complex sales involving 2 or more legs like: credit put spreads, credit call spreads, iron condors, iron butterflies, straddles, strangles, and calendar spreads.

– My favorite: Portfolio Theta decay!
It’s about $1.70 at this moment, which means the value of the sold options position decays at $1.70 per day, which is like I’m getting $1.70/day on an mathematical expectation basis that gets realized when I close out the position. Theta decay changes based on a few things, mainly time to expiration and implied volatility of the option.

Optimization: for future sales, try to sell on a spike in implied volatility from a recent steep downswing for better options pricing, and for higher underlying volatility that leads to higher Theta decay. Less significant for further out of the money options since Theta and Vega don’t get affected as dramatically.

Exit Strategy for $XXII

Thinking through how to exit out of my $XXII 10k share position, which I got in at $2.00/share and is now trading at $2.60/share.

1. Tax consequences

I want to get out of this position by August this year since that’ll be 1 full year and the earliest I can get taxed at the capital gains rate, instead of the ordinary income at about twice the rate. But I don’t want to simply sell via a market order (or close to the market via a limit order) when the time comes since that fetches the market value and there’s a way to eek out a lot more profit using options.

I don’t plan to ever hold a single equity position for at least a few years, since I simply have no edge. I freely admit I’m just a sucker who got lucky thus far with $XXII while I was trying to find a trading strategy that suits my skills. Holding the underlying stock, in this case and in general, requires too much capital tied up that could be used as margin collateral for the options selling, which is where I can trade with an actual well-researched statistical edge called the Implied Volatility Premium of about 3%-5%.

(With all these estimations, I’m ignoring the effects of transaction costs since they’re small. Also assuming that any exiting of the position will occur after August, so that there’s no relevant issue between a blended cap gains and ordinary income tax rate.)

2. Selling calls and continuous capture of time decay

I’m thinking of selling the January 18th, 2019 $5.00 strike calls, that expires in 387 days. Market price for them is $75, each controlling 100 shares. I can exit out of this net selling position by “buying” back these calls, which will “decay” in value from $75 to $0.00 continuously as we get closer towards Jan 2019. This is called “theta” time decay, it’s like I’m a landlord charging rent.

3. Entire $XXII position

I can sell 100 calls to equal my entire 10k share position. In doing so, I immediately get $7,500! That $7,500 can be used in any way I want, even withdrawn into my bank account. If I want to exit my net selling position, I would buy it back at some fraction of the $7,500 and bank the difference as profit.

4. Scenarios

Scenario A: $XXII does not reach $5.00/share by January 2019

I get to pocket the full $7,500 while still holding the 10k shares.

Meanwhile, each day that goes by, I win via theta decay in option value. This phenomenon applies to all other scenarios as well.

Scenario B: $XXII does get above the $5.00 strike

I would still be winning until it reaches $5.75, since this would be equivalent to selling $XXII outright at $5.75.

Scenario C: If $XXII gets above $5.75

I still win from the appreciation up to that point, but miss out on all the gains over $5.75. This is the truly riskiest part of this strategy. What if it goes to $12 or $20 very quickly? I completely miss out on that upside.

5. Exercise

Usually long call options holders don’t exercise calls until near the very end. So If $XXII gets above $5.75 in the meantime, and it seems like there’s going to be an explosive move upwards, I can always choose to buy back the sold options positions to keep my net long stock position. I would choose a time when XXII takes a downswing, since then the call options would be cheaper to buy back. This isn’t 100% technically true though, since the volatility may increase the option price more so than the downswing of the underlying decreases it, but it’s probably not very likely unless it’s a very huge downswing. I’d have to actually calculate the numbers, but then that would be venturing into excessive false precision territory.

6. More shares issued

There’s a good chance there’ll be more shares of stock issued. In which case, it’ll only serve to decrease the probability that the $5.00 call strike price is hit.

…

After writing this all out, I believe the correct decision for my portfolio are as follows:
– sell 100 calls at $75 each for $7,500 and capture the Theta time decay
– this way, I can plan to exit out my $XXII position while capturing theta time decay every single second of every day
– I would get free cash immediately that I can then use for other trades
– I can always buy back $XXII on a dip after it gets called away, with a subsidy equalling the price of the sold call option
– still need to ponder since the risk I assume is missing out on a “To the moon” explosive move upwards by $XXII

Liquidity Premium, Limit Sell Orders, and Call Options

For those trading Bitcoin and cryptocurrencies, it’s interesting to think that a large portion of your returns may actually be derived from the increased risk from lack of liquidity, as we see some exchanges stall, crash, or even completely shut down, or new regulations and laws make exiting or entering positions increasingly difficult. This illiquidity actually exists in traditional asset classes like real estate as well, where it commands an (il-)liquidity premium. I haven’t done the research, but I wouldn’t be surprised if many university endowments and long-term investment funds derive a huge portion of their returns from this liquidity premium as well.

Here’s an interesting case study I did to try to understand this liquidity premium in a more liquid market that contains a robust and parallel derivatives market.

One way to interpret the selling of call options on securities you own (covered calls) is the price the market is willing to pay you for providing liquidity, points to how important liquidity is to the market, and how crucial derivatives markets are for price discovery, risk management, market efficiency.

Some interesting hypotheticals as I plan to exit out of my 10k shares of $XXII, which are now trading at $2.56/share.

I was thinking that instead of placing a LIMIT SELL order on the $XXII itself at a price target of $5.00 to lock in a $30k gain from the 10k bought at $2.00 … what would happen if I instead sold 100 call options contracts, each controlling 100 shares for the total 10k shares, at a strike price of $5.00 expiring in 6, 12, or 24 months instead?

It appears I can sell options expiring on the following dates for the amounts listed for the $5 strike calls. If $XXII stays less than the $5 strike price, I can keep these premiums. If $XXII rises above $5, then I miss out on any potential upside equal to $5 plus the premium received. See below for screenshots from my broker’s platform. These are of course estimates at this very moment, and are subject to change depending on market conditions.

• $4,000 for the July 20, 2018 expiration
• $6,500 for the Jan 18, 2019 expiration
• $12,500 for the Jan 17, 2020 expiration

These amounts can be viewed as a loose, partial, and derived indicator of what the market is pricing liquidity as. It’s not exactly one-to-one since these call options market prices factor in underlying price, volatility, time, and interest rate risk, as well as their 2nd to even 7th partial derivatives, if we want to model beyond the 2nd order Black-Scholes options pricing model world.

Interestingly, people view Warren Buffett as, and he claims to be and highlights the fact that he’s a buy and hold value investor, but he’s also a big time options trader as well. Below is also a screenshot from the 2008 Berkshire Hathaway annual report where Buffett discusses the $4.9 billion premium he received by selling PUT options on the S&P500, FTSE 100, Euro Stoxx 50, and Nikkei 225 indexes.

Options trading as shown in Berkshire Hathaway’s 2008 Annual Report

XXII Calls: 2018 July

XXII Calls: 2019 Jan

XXII Calls: 2020 Jan

Quick Thoughts: Bitcoin and Cryptos

My view on Bitcoin and cryptos:

1. Bitcoin is only one of thousands of cryptocurrencies and it has deep inherent flaws that may be solved by other Cryptos. It’s a v1.0. It’s 100% a bubble, but that’s incomplete and almost irrelevant.

2. Short term trading is different from long term investing. You can make money on pure speculative bubbles and lose money on real assets, in both time frames.

3. There’s other uses of cryptocurrencies, all these arguments are centered on speculation and to lesser extent medium of exchange, which are totally incomplete. But there are others like store of value and public ledger and a few others I am ignorant of. Each in their own way challenges existing institutions.

4. The public blockchain technology has ramifications in other ways beyond currencies, such as proof of work and credit attribution for distributed computing. When all this gets combined with quantum crypotographic protocols, there are further issues to consider that many haven’t thought of.

5. Is it a currency or derivative?
It can be both. Though the proper analogy may be: (1) currency vs credit, and (2) underlying vs derivative.

For (1), that’s as a form of social trust. That’s what currency is, Central Banks create it out of nothing. Same with credit. For (2), it’s both underlying security and derivative on the underlying. If the underlying is social trust, Bitcoin is a derivative. If you can trade futures and options on it, then operationally it is the underlying for “those” derivatives and act like a currency.

6. Definition issue
There are different implications depending on the definition, that in turn comes from how the crypto is being used.

7. Bubble
Whether or not it is a bubble issue is only a small part of the picture. I believe 100% it is a bubble and is dangerous. Can you make money on it even if it is one? Yes. Are there uses for it even if it is dangerous? Yes.

Tempo in Tactics and (Meta-)Strategy

In chess, poker, and Starcraft there’s the idea of “tempo”. I’ve been thinking of how this applies to trading strategy.

The main theme of “tempo” is to force action, compress decision timeframes, and speed things up in order to win at a smaller timescale and more tactically so as to neutralize all long-term strategic disadvantages that accrue.

– In chess, tempo means to initiate the exchange of pieces, even when you lose out in relative value of exchanged pieces so that you neutralize strategy that benefits from the building up of complexity and passive position, in favor of simplification and forced action

– In poker, tempo means making bets that are larger and earlier in the betting sequences to win immediately or by forcing opponents into making a definitive choice, where mistakes can result

– In Starcraft, tempo means going for earlier rushes, not building up economic resources, and attacking rather than defending

In active trading, tempo may mean making large bets where you have higher probability due to short-term momentum of the underlying security or mania. Cryptos seem to benefit from tempo in making large bets and getting out soon (though the case could also be made for making smaller bets and holding long term).

There’s absolutely nothing better or worse in choosing higher or lower tempo meta-strategies, but it’s important to distinguish them and understand their strengths and weaknesses to think more clearly and choose the correct course of action that best matches that meta-strategy. More importantly, however, is what matches your own personality and preferences.

The strategy I’m taking with options trading is opposite to trading large single positions. Interestingly, it is both higher tempo in some respects and lower tempo in others. It’s taking smaller bets ideally closer to 1% of risk capital per bet, and scaling “horizontally” in terms of number of trials, as opposed to “vertically” in terms of larger bets on a fewer positions, and striving to achieve an infinite number of bets such that the implied volatility premium works itself out in the statistical long-term, much like the dealer or slot machine owner does in a casino. It’s lower tempo in that you’re striving to making non-forced boring small bets that should be viewed as only one of an infinite number of trials. It’s higher tempo in that to realize large numbers, you need to be making a lot of them and active with all bets, even if you can be passive with any single bet. Instead of a one-shot big bet to win huge instantly, I’d like to have it build up in a very controlled fashion that approaches the precision of the statistics of the Black-Scholes world if possible, realizing with almost perfect certainty small edges that cause a smooth growth curve.

It’s interesting to think of this in terms of two braod views:

1. maximizing win “rate” and lowering amplitude of swings at the cost of lower total profit expectation

…versus…

2. maximizing total profit paid for by a lower win “rate” and increasing amplitude of swings.

The Kelly Criterion used to determine the optimal betting size is the latter of maximizing growth, but it’s probably unrealistic since humans with normal brains tend to really hate volatility. Humans seem to favor higher probability and frequency of winning, as opposed to and at the cost of overall payoff, most likely because of the underlying evolutionary cognitive mechanisms where the utility payoff function favors maximizing the likelihood of survival in the near future, period, as opposed to what happens after that.

Cryptocurrency Options and Irrelevant Concerns

The CME Group, CBOE and Cantor Fitzgerald have announced they’ll be offering products with exposure to cryptocurrencies. Yet another step for cryptocurrencies to be fully accepted into the mainstream. It’s especially interesting to me since with new underlyings securities come derivatives on those underlyings, and especially “options” along with their implied volatility premium for which to trade and profit from

Speculation abounds, for example, concerning: whether cryptocurrencies are here to stay, whether they’re real or not, whether they’re hackable or not, what they mean relative to fiat currency, and so on. Some quick thoughts in this regard follow.

Whether Bitcoin and cryptocurrencies can be hacked or not is actually irrelevant and doesn’t really prove they aren’t viable. If anything, it shows how “real” and viable Bitcoin and cryptos are and increasingly are now, since people trying to steal them means they’re actually worth the energy and effort to try to steal them.

There are many uses for cryptos:
1. Medium of exchange
2. Store of value
3. Speculative asset
4. Secure public record

In a public discussion, someone mentioned something along the lines that cryptos are hackable given “right resources, networking and malware one –likely a team– could hack thousands if not millions of computers at the same time and avoid detection.”

My view is that that question is limited and/or irrelevant, since it doesn’t account for how much would it cost for that? What would be the reward to risk? If hundreds of thousands or millions of dollars are spent, human time/energy/attention, and face jail time, the reward to risk ratio is more important than whether it’s “possible.”

In a previous time period as the founder of a tech startup, an accelerator interviewer asked me: “What would you do if Google poured $100M and 100 people into  what you’d be doing?” It’s an analogous irrelevant, since Google wouldn’t want to expend those resources and would rather want to buy a startup doing the same thing for 10% of the price and 1/50th of the people.

If we’re worried about “hacking” or “stealing” money, consider the Fed.

There is actually no printed money in terms of physical specie most of the time. It’s just digital information in various accounts. Money is literally created out of thin air, and that may devalue the money you own more so than any hacker could do.

The Fed can also perform open market operations such as buy or sell treasuries that may greatly modify the supply/demand of existing treasuries and thereby affect the value of all other asset classes such as stocks, corporate bonds, futures, etc. And there’s even greater consequences of bad monetary policy for inflation. The rate of inflation can massively affect the value of fiat currency. And so on.