The Derivative - There’s no Stupid Options questions, just Stupid Options Courses, SurgiFi attends Benn Eifert’s Class

Episode Date: August 23, 2022

Summer’s nearly over and class is definitely back in session for this episode, as we're about to get schooled on options and trying to separate the scams from the science. This week we're delivering the long-awaited episode with Dr. Benn Eifert, a Derivative appointed Jedi of Volatility from QVR Advisors, and Dr. David Rhoiney, who overcame being homeless to become a robotic surgeon who is learning the financial ropes and sharing his journey on Twitter from Surgifi. David has questions: what do you do with all the Greeks, can’t you tell a trend is starting by analyzing options volume, what about skew?  And Benn has the answers in this entertaining 70-minute lively back and forth. They touch on being an independent thinker like David to come to your own investing conclusions, whether the options courses out there are knowingly selling lies, or more innocently peddling luck and lottery tickets. Why Black Scholes doesn’t really do anything except normalize prices…meaning there’s no secret math that lets you ‘figure out’ options. How trend following only works 25% of the time, Nancy Pelosi’s high fee LEAPS trades, Nassim Taleb’s tail hedges, why it counter-intuitively makes sense to add a losing asset to your portfolio, and so much more! Plus, we discuss should retail investors walk away from options and how not to get caught up in the index funds cult — SEND IT! Chapters: 00:00-01:54 = Intro 01:55-21:52 = Greeks, Bid/Ask, a Tech Stack… where do you even get started? 21:53-39:36 = Implied Volatility doesn’t tell you anything about what to do 39:37-58:36 = Someone selling you a trade based on skew = run the other way 58:37-01:12:15 = Pelosi’s LEAPS? Taleb’s Tail Hedges? Why add a losing asset?  01:12:16-01:17:22 = Hottest takes: just walk away from Options, steak is overrated, and the Devil’s nipples From the episode: Benn Eifert's Tweet on adding Tail Risk Surgifi's newsletter Follow along with Benn Eifert on Twitter @bennpeifert and David Rhoiney on Twitter @FiSurgi. For more information on QVR Advisors check out their website www.qvradvisors.com and for more on Surgifi visit surgifi.com Don't forget to subscribe to The Derivative, follow us on Twitter at @rcmAlts and our host Jeff at @AttainCap2, or LinkedIn , and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Welcome to the Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Happy Tuesday, everyone. Coming to you a few days early this week after a week off from my summer vacation where I ate my weight in oysters, lobster, and clams. Good work, Northeast. You really know how to serve up the melted butter.

But with summer vacations wrapping up, it's time for school. And we're getting into the spirit with today's episode where we have the professor of vol himself, Dr. Ben Eifert, teaching us all up and answering some questions from a pupil he admires and respects for not taking what YouTube has to offer, but instead seeking out his own version of the truth. That's Dr. David Royney, better known on Fintwit as Surgify. We had fun on this one with Surgify throwing vulnerable to the wind and asking the questions some may be afraid to ask, and Ben finding new and ever-inventive ways to say, no, that's dumb, run the other way, and terrible idea.

He never actually said any of those things, but it was implied. We also had surprise pop-ins by both of their little boys, too cute, and I probably talked as little as I ever have. So if you're into that, this is your pod. Send it. This episode is brought to you by RCM's Lunch and Learn series, where we highlight different hedge fund and mutual fund managers specializing in unique alternative styles and strategies. Unlike the pod where we do somewhat similar thing, here's open for questions. So pop on into those and ask these guys as many questions as you have, similar to what we did here today. Head on over to Twitter and find at RCM Alts to sign up for this week's entrepreneur where I have my friend and fellow seeker of truth, Jason Buck, talking through volatility in a portfolio setting, which we get into a little on this pot as well now back to the show

okay class is in session welcome ben welcome david good to see you guys i've uh continued my one pod episode tradition of trying to match ben's style with the shirt game here last time he had a hoodie so i went and changed into a hoodie so i could imagine we're doing fun shirts yeah fun shirts sorry david you want to go change quick uh well so here's the crazy thing i used to have shirts like that. And then my wife said, you're getting rid of all of them. And when I left on to Cuba while I was gone, they magically, magically got by the by the movers. Let's just put it that way.

It's a really sweet Hawaiian shirt that she was never a fan of that has gone bye bye. I love it. So we've all got questions ben usually has answers enter david learning the ropes and sharing his journey via twitter and sub stack at surgify uh so david you found options ben you know options and i threw out the idea it'd be interesting to sit back and listen to the q a between the two of you so let's let the teach begin fire away david yeah uh so first off uh ben is the guru of all things volatility in my opinion right um matter of fact when i was learning options i just searched ben uh eifert's name uh and my podcast apple podcast app because app, because he's in. Do you have the most oddlots appearances? Because majority of them are oddlots appearances, dude.

I think I'm tied now again at five with a couple other guys, with Matt Levine and maybe somebody else. But yeah, I was behind until a couple weeks ago. That's a good company to be in. But I mainly wanted to learn options, not necessarily to do it myself, but I wanted to know why people say it's good versus it's bad. Right. And the biggest thing is there's a lot of crap out there for retail investors. Specifically, if you go on YouTube and you just search options, I mean, there's a lot of crap out there for retail investors. Specifically, if you go on YouTube

and you just search options, I mean, there's so much stuff. And then during the height of the pandemic, I mean, let's just be honest, man, when the market was going crazy, like Ray Charles could make money by just throwing something at the market, right? Because everything was just turning into gold and people were selling all these options courses. And then I knew something was wrong when I was having people come to me saying, oh yeah, you have to try this strategy where I just sort of rotate some things. But I'm like, I heard of these things called Greeks. Like, are you not paying? All of those things don't matter. And I'm just like, I don't know about that. Right. And so I posted on Twitter. I was

like, Hey, you know what? I really want to learn options. Where do I get started? And the guru Ben said, Hey, you got to read the Nadenberg book. If you're going to be smart about it and you really want to learn this stuff, start with the Nadenberg book. If you can understand this, then you can start to get your head wrapped around options trading. And so I went and bought the book. And this, ideally, I'm assuming this is part of some financial engineering textbook for a class, right? Because this is high-level stuff. And I took my time and I freaking highlighted pages and I studied it just like I would medicine. Right. And so what it came down to the short term conclusion is one options are complicated to why would anyone in retail ever do

this? But if you're going to do it, like where do you even get started? Right. So how do you wrap your brain around when a retail person should even consider even starting getting options exposure? Totally. I mean, you know, first of all, I think, you know, part of the reason why this is fun for me to do and why we talk on Twitter is like, you know, you're very smart and reflective guy, right? You're a surgeon by training, but like, you want to understand concepts and arguments from first principles. And you're very anti like, taking a conclusion or a common piece of wisdom that somebody offers at face value, right? Even if you think they're probably right, like, you don't want to be done there. Right? Like you like to kind of engage almost in this like discourse, like in philosophy or whatever, and like build up knowledge from like the bottom pieces and like kind of make the connection in your brain where you're like, okay, now I really understand this, right? And I think that that's something that a lot of people just don't do,

right? And so as a result, a lot of people actually don't understand the things that they, you know, they say, or they think that they believe. So I think that that's, you know really cool and i think that's why you know it's fun to you know get into this stuff with you so um is that why you gave him a book six six feet thick yeah exactly and um you know like an analogy a little bit uh you know something that i will deal with but it's like when i when i teach junior quants uh you know from to to do uh you know what we do um i think it's essential to like force them to initially write the code to construct like the standard analysis concepts like covariance or linear regression or maximum likelihood or whatever like from their rawest components of linear algebra and like build up to like those analyses and people are like well but you can just like download the thing that does that like why would you do all that work and the

point is like it's because dealing intensively with actually understanding the building blocks to like get there actually makes you understand what you're doing like a million times better right as opposed to just being like oh well okay somebody told me that this works and i can just like use this thing that works right and so i think you know that's like you know i think you know david really came at this space again and you just said this right but not because it's like oh i want to learn like some ways to make money or something. Right. Because, you know, fast forward. But like, that's that's not how it's going to work. Right. It was more like, I want to understand this. This is interesting. Like, I'm a smart and intellectual guy. Right. And I really like that. Yeah, I mean, for me, let's just be honest. Right. That's right. The majority of the money made in the market for a retail investor is going to be hands off, like sitting on your like really monitoring your behavior.

And a perfect example is like a classic story of the person that's just like, hey, I kind of like X, Y and Z company. I'm just going to keep buying that and I'm never going to sell because I like X, Y and Z company. I'm just going to keep buying that. And I'm never going to sell because I like X, Y, and Z company. And they didn't pay attention to the market through all these downturns and all these crazy little news cycles to Jen Kramers of the world who liked to spout nonsense on TV. And then after a while, they're like 89 years old and then they pass away. And then everyone's like, oh, they just happened to own thousands of shares of this company and they've owned it from 30 years and nobody knew. And then they turn out to be uber rich. Right. So buy and hold is by far the biggest thing for a retail investor, in my opinion. Right. However, I know that not everyone's going to be swayed by doing that because it's boring. There is nothing exciting about that. And to be honest, options to me is like playing in the NBA, right? Like that's

fast paced. It's exciting. Like that's the sexy thing. And like, I'm the most unsexy individual you'll get, but I kind of want to understand like what's going on right and so with the options trading stuff half of it is one like how do you manage actually paying attention to all of the Greeks or do you even need to or do you just pick one and go I'm going to focus on this know it very very well and know how to get in and get out like how do you keep them all in your head? Or do you even need to? I think you got to back up for a second and just start with like, what are you actually trying to achieve, right?

As opposed to kind of like, what Greek are you looking at? Or like, what are you doing, right? So it's like, I think maybe just, you know, one starting point, right, is like as an investor in general, right, you should theoretically get paid over the long term for taking risk and providing a service of some kind with your money and your

capital, right? So it's like, that's why, you know, owning equities or credit, right? You're providing capital to businesses, you're taking the risk of, you know, that the world falls apart or whatever. And like, you get paid for that over time. And like owning government bonds, same thing. You're providing capital to governments, You're taking some interest rate risk. In the derivatives world, it's a lot more multifaceted. I mean, I guess the analogous thing, and you hinted at this a little bit, is probably something like over time, you'd think theoretically you should get compensated for selling options because you're providing insurance to people and organizations that need it or that want it. But like, there's a lot of nuanced cautionary points embedded in that. And, you know, we can talk about that, right? But like,

that's the first level thing is just, if you're an investor, like, why should you think you should get paid, you know, on your money? It's because you're putting capital to work doing something that is providing a service to somebody, right? If you're thinking about anything that's like feels like short term speculative trading, like your starting point is probably that, you know, there's no there's zero expected return to whatever you're doing. And that then there's negative expected return after you factor in that there's like pretty material trading costs in a lot of cases, so especially in options, right? If you're going into your brokerage account and trying to buy and sell options as a retail investor, like you're going to be paying lots of money to market makers and that's just straight out of your pocket, right? And so when you think about the

question of, you know, hey, I'm a retail investor, I want to do something in options. The first question you just have to ask is, what is it that I'm trying to do? What is it that I think I'm going to be achieving? Right? Is it that you're trying to do that, you know, that thing that we kind of talked about putting capital to work and trying to trying to get paid for that. And you're looking at some kind of in that case, probably, you, probably careful option selling strategy, in which case there's a certain set of things you're going to think about when you're trying to do that. Is it actually that you have some particular views on stocks that you like, and you're trying to use options to express those views in a different way? So if you just own a stock,

you're like, okay, I'm going to get paid the dividends. And if the stock goes up, I'm going to make money. You might have a more specific view like, well, I don't really think that the stock is going to go up that much, but I really think it shouldn't go down that much. And maybe your view fits better with selling put spreads or doing something like that, right? There's a whole category of like using simple option trades that correspond to your view on a stock. And again, that's hard, but like there's going to be a different set of things you're thinking about, you know, if you're doing that, right? If you approach options, you know, from there's a whole lot of options in the world and there's a whole lot of Greeks and like, what should I look at? Like,

you're just going to kind of be lost, right? You got to start with like, what is it that I'm trying to do and why, and why does it make, why do I think it makes sense? And then what do I need to know in order to do a good job of doing that? Well, so you brought up, we've had, obviously me and you have had a ton of conversations in the last like year and a half. I can, I can basically call you a friend now because I mean, we, we talk about random stuff. Right. And you know, you mentioned something before he was like, Hey, you know, the option stuff doesn't really matter. Cause like you have to start with this case of like,

what are you trying to achieve? Then you go look for the trade to get you to the point that you're trying to get at. Right. And I feel like there's a lot of technical details and options that can easily, you can drown in and you can lose what the big picture is. Like you get lost in the forest for like the trees and stuff. Right. Like you can't be able to see what your ultimate goal is. And I mean, in the book, it talks about like, if you're going for directionality, you need to look at here, or if're going for directionality, you need to look at here.

Or if you have a market sentiment, you need to look here. The interesting thing that really intrigues me from an option standpoint, and it's still kind of confusing, right? And it gets thrown around as jargon a lot. It's like it talks about risk premia, right? And honestly, I'm not even 100% sure that everyone understands, has the same definition of what risk premia constitutes. Because if I talk to one person who's a financial advisor, I talk to someone who's an investment manager or asset manager or whatever, they all discuss risk premia in a different context, right?

It's not really, in my opinion, I haven't found a great way to quantify what risk premia in a different context, right? It's not really, in my opinion, I haven't found a great way to quantify what risk premia is. It's just basically like, hey, I should kind of get paid for like taking on this risk. And the thing that I look at so far and with my little novice knowledge from reading this giant textbook is I'd rather be the sort of the person that's dealing out, like selling insurance or being on that side, right? Because I don't think I would ever know enough and be able to track enough to actually trade these things effectively. The other thing is I feel like this is a space where, and please correct me, I'm wrong. If you're doing it in very small sums, then they're really, the hassle isn't worth it, right? Because the trading costs that you don't have to really,

that you aren't really appreciating as a retail investor, like if you're doing this through your Fidelity account, right? You have no idea what's going on in the backend. And from the people that I've talked to who do this professionally, they're like, yeah, I have this interactive broker's account. And I talked to these people and I'm like, I didn't even know that stuff existed, man. Like, why do I need to care? If I'm a retail investor, why do I care about the bid-ask spread? Well, it turns out you need to care about the bid-ask spread because that's how you save money. And this whole thing is about preventing your money from going places that you don't want it to go. Overall, part of like how something that I think varies to what I've seen so far. And Ben, you're an economist like economists take this sort of macro view like they look at everything and then they sort of funnel it down to figure out specific scenarios.

But and please excuse me if I'm wrong, but economists are like weathermen to me. They're going to get that shit corrected once or twice in the world. Excuse me for cursing. But if you look at the weatherman or woman, they're not correct all the time. And they shape the narrative. So if I know I'm not going to be correct, how can I even determine what option to even look at? Because it's like reading tea leaves. I could be a hundred percent wrong. And as a person who likes to analyze numbers,

that doesn't give me a warm, fuzzy feeling that I can even be correct. Yeah. I mean, I think that's right. So, you know, back to the kind of things that, you know, what goal are you, are you trying to achieve and what kinds of things can you be doing, right? If you don't think you have a productive way of coming up with a particular directional view and timing on a stock, which by the way, is the right view, because that's really hard. And like, you know, why should you think, you know, that's obviously what long short equity people are doing all day. And it's difficult for them to like, have a good sense of whether Facebook's going up or down and over what timeframe or whatever, and then come up with

a good options trade to start with, right. So as a starting point, if you don't think there's a good reason to think that you're going to be able to form a particular directional view that is, is, is reliable, then you shouldn't think you should be trying to punch around option trades on that in the, in those kinds of cases. Right. You know, to, to your, to your earlier point, you know, the concept of risk premium you know, that the concept is straightforward enough. But the, but quantifying risk premia is not easy. Right. So you can look at for even just inequities, which are much simpler than options and derivatives, right? You can look, okay, at like long, what are long term US equity returns? You know, you can look at long term historical equity returns in the US, you can say, oh, well, like over a very long period of time, US stocks made like 7% per year or something,

right? But that, of course, varies massively over different time periods, even pretty long time periods, like 10 years, 20 years or whatever. Right. So it's like, does that mean that you can buy some, buy some S and P index exposure and think you're going to make 7% like over the next seven years? Like, of course not. It's like a big old distribution around that. Right. And then on, you know, in options and derivatives, it's even more complicated. So yes, you should think on a standalone basis that providing capital and providing insurance to people who need insurance should be something that you should get paid over time is massive. And that's something that I talk about a lot and have talked about a lot. Like there was a time period from call it like 2017 to 2020, where it was very clear to a lot of options and derivatives people that actually there had been so much naive acceptance of the idea of volatility risk premium. And so many people, by the way, including very large, humongous institutions with massive amounts of capital, just blindly selling options at any price that there was a negative risk premium in options. You were actually expecting to lose money and have a negatively asymmetric bad insurance like payout profile.

So like if you're selling, you know, you're just completely crazy to be to be selling options in that kind of scenario. And so, no, it's one thing to have this concept of like, okay, long-term, theoretically, there should be this risk premium in different asset classes. It's a different question of, can you reliably quantify that at a point in time, given what's going on in the world? That's really hard. And it's hard for people like us who have an enormous amount of infrastructure and resources, much less for an individual investor who's got a lot of other things to do.

Well, it's funny. I'm sorry. Go ahead, Jeff. I was just going to say, it would be fair to say, like, part of me is David's coming at it from, hey, trade options and you can make this money, right? It's almost a level up of the courses. Everyone's saying just the trading of the thing is what makes you money. And we're kind of backing up and saying, no, you need to have an idea of what you're trading, not just options by themselves. It's no different than trading Beanie Babies or crypto or whatever, right? Just the trading itself doesn't, because they're options, doesn't lend itself to some other premium that you can make just because they're options. Yeah, it's totally the opposite. As almost any investor, you're going to pay a lot more transaction costs and spread to market makers and exchanges to trade options than anything else. So you're going to be losing a lot more money,

sort of doing stuff in options, right? And that should be like your starting point is why do I think that I can actually overcome that for some very specific reason because of some, you know, something that I understand about the markets and, you know, your bar for thinking that should be very high, right? I try and, like, with concepts that or things that I don't understand 100% of the nuance, I try and get it to things that I know I understand reasonably well, right? So this is the reason why I, like, I remember I asked you, I was like, hey, you know, is there like a formula that people use or, and you're like, hey man, the math is actually very simple. And I'm like, but it has to be like something like, I'm trying to get to like the math, right? Because I can translate math. Right. I'm applied math mathematician by my education.

Like, OK, let me just look at the math. I can explain that. However, the thing is, I'm looking at like these black shows formulas to put put called parody stuff. And I'm just like, there's no effing way that anyone's calculating this stuff when they're making a, making these decisions, because they're happening too fast, right? And there's not enough data. And I mean, maybe I'm not smart enough to figure out the algorithm that can dynamically do this on a second, a millisecond basis. But I, there's, which leads me to say that, you know, there's a lot of nuance here. And people are doing this based on experience. Right. So then I'm like, well, if that's the case, implied volatility is a calculated thing. Right. Because that essentially best guesses on historical data, if the market doesn't, like historical prices don't predict like the forward performance. So that doesn't

sort of add up to, for me, it's like an equation, right? So that if the past does not equal the future, then why are you looking at past data? Does that make sense? There's a couple different questions there. I'll try to kind of separate them and unpack them. So I think the first thing is kind of a question about, you know, capabilities and technology infrastructure or whatever. And that comes back to your kind of point about like individual investors who have stuff to do versus, you know, I mean, obviously people like us and the people involved in, in this market who are specialists have extremely large technology, technology infrastructures that see all, you know, see calculate anything that you need to calculate in extremely low latency constantly in really sophisticated ways.

Right. So like, and that's just like a, whatever, like, it's the same thing as like, you know, Google's real time ad auctions or whatever. Like, could you be like, I'm going to go compete with Google in the real time ad auctions market? Like, like why, why would anybody ever think that? Right. It's like, you know, there's a huge amount of money spent and infrastructure spent, you know, doing this kind of stuff. So that's, that's one piece.

The next piece is what is implied volatility? It's just a normalized price. It's not. Literally, it's just saying, well, there's different maturities of different options and there's different underlyings with different prices or whatever. And it doesn't tell me, if you tell me, I see an option that's trading at $171.25. What do you think? That doesn't tell me anything, right?

Because it's like, well, I don't know. Is that a lot? Is that a little? It depends on a million different things that you didn't me anything, right? Because it's like, well, I don't know, is that a lot? Is that a little? Like it depends on a million different things that you didn't tell me, right? If you tell me that, you know, the implied vol on this particular option is 72, that tells me more information

and that's more comparable between a one year, 20% out of the money option on Tesla versus a three months, you know, 10% out of the money call option on, you call option on Microsoft, that gives me a lot more information about how to compare those things. But that's literally all it is. Black-Scholes is just a normalization that's kind of like a Z-score in some multidimensional space that just gives you an accounting framework for understanding option prices in a normalized way, right? It doesn't tell you anything about like, is that option expensive or cheap or anything, right?

It's literally just, it's literally just, you know, simple data manipulation. So getting, so then to all of your questions about, well, like, how do you know what to do? Doesn't tell you anything about what to do. It just gives you a clean, that whole technology infrastructure, literally all that it does is just give you a clean picture of what the prices are right now. And if you don't have a clean picture of all the prices right now, and you're like trying to do something sophisticated, obviously you're not going to do a good job of it because you're just, you know, you don't even know what the price is. How are you supposed to know what to do? But knowing what the price is doesn't have anything to do with understanding what,

again, back to what is your objective? What are you doing, right? So we talked a little bit about how, you know, investors, you would think, make money putting capital to work, taking risk, and those kind of things. You know, some kinds of institutions, so like us and like market makers, right, we get paid for other things, right? People get paid to provide primary liquidity, right? And that's when retail investors go and trade with market makers, market makers are getting paid for providing that liquidity byations in market prices that come from big transactions that people are doing that are making things kind of have the wrong price and for understanding that and providing liquidity to that and warehousing basis risk like those are the kind of things that people like us get paid to do like those are not really things that are accessible to you know to people who have, you know, a lot of other stuff to do and like haven't been doing this for 10 or 20 years or whatever. Right.

And there's not like, so the, the, the problem of can I count, you know, even if, even if you had a technology infrastructure that could tell you what the implied volatility is of everything in real time, right. There's another huge gap from there to like, well, what do you do with that? And how is it that you think, what are you going to get paid for doing and how and why? And for you guys, Ben, and people like you, you have your model calculation that's saying what you think the price should be and then what the actual price is, and then can see that dislocation. Is that a somewhat fair representation?

In some very high level sense, yes. That's not in practice what it really looks like. It's not like this option is worth $12 and it's actually $13. But what we think about is how do you think about different, very specific kinds of dislocations how do you under where do they come from how do you identify them and quantify them and how do you how do you take advantage i think that's important point i think retail and the courses out there selling this are like hey you can find the magic formula that lets you get the true value of this option yeah that's total nonsense yeah i mean that after reading this book, it's 100% nonsense. There's no way.

There's no magic formula. And Ben, and I'll caveat this. When I first started to ask about options to Ben, Ben was like, David, you're a surgeon. Don't waste your time on this stuff. It's not worth it. You have other ways. I'm like, look, I just kind of want to know, right? And he's 100 percent correct.

I now that I've read this book, I have no desire to ever even look at options ever again. Right. Because the reality is, is I don't have time. Like I read probably every morning and I stole this from Barry Ritholtz is I asked him like, hey, you know, how do you keep track of what's going on in the market? And he told me his setup on like what articles he reads and how he set up his. So I did the same thing. So I literally go to my Google news feed that I like set up all this stuff. And I just read through that stuff and I'm done. I don't even pay attention to what happens in the market because I don't have time to sit there and do all this stuff. And so I'm just confused how someone, let's just call them Jane, right? How Jane goes to work and is supposed to put on an options trade

in the morning, be able to watch this while she is taking care of whatever she's doing at work, and then magically can close the trade right when she needs to close it to make the amount that she wants to make. And I just don't see that scenario, right? Unless you're doing this full time. And then I talk to people who are professional investors and they go, yeah, I don't do this for my personal account and it's not worth it. And then I'm like, well, if they aren't doing it for their personal account, why the hell would I do it for my personal account? Totally. I mean, I think if there's a couple of different things that I like doing and try to achieve with substantive content on Twitter, there's obviously also a lot of non-substantive content, as you guys know. But I think the single most important of those as it faces, you know, the huge amount of people that follow me who obviously mostly aren't specialized derivatives people because there aren't that many specialized derivatives people is like, you should come away thinking that like, I don't want to touch any of that stuff. Because, you know, it's complicated and it's harder,

it's harder than people make it seem and all that stuff that seems really easy and obvious and how, how it's like, there's like this get rich quick magic is obviously lies. Right. And I think that's really important. But is it lies or is it luck or both? Right. Cause you can see what were the headlines today. Some kid made $110 million trading FedBath and Beyond options and all that stuff.

So it's like part of me wants to say, hey, are we too smart by, too clever by half to quote whoever that is. And we're trying to think of all this fancy stuff when someone just buys these teenies and it's more of a lotto ticket type investment. If they know that is that so bad yeah and like you know i haven't looked at that you know that kid uh i don't i

think framing it as a kid thing is a little weird he had like 25 or 30 million dollars or something like that he was investing right and so like he bought some call options and they went up but like you know and i don't know how many I know. So having watched closely and commented a lot on the GME AMC stuff back last year, you know, you see this kid again, kid, but I can tell you, there are a lot of people who made a ton of money doing similar things in GME because it was sort of the first time we'd really seen that particular dynamic happen. And there were a lot of hedge funds making really bad risk management decisions on the other side and sort of providing these people this opportunity.

A lot of them then turned around and lost all that money or most of that money, having thought, hey, look, I'm really good at this. I'm smart. Like, look how good at trading options I am, and then got crushed over the next year or two, you know, doing because, again, like, you know, that was a very unusual moment in time. And there's still little bits of that, you know, coming out. And actually, I think some of the people that were involved in those trades early on were quite smart and quite thoughtful, and actually much smarter about how they were thinking about them than the hedge funds on the other side. And that was like a really cool story. And I've talked about that a lot. But the right lesson to learn is not, you know, short term punting around in big size on options is going to make you rich, right?

I'm sorry. The Chicago term for it is terminal break even, right? I'm like, hey, eventually in these trades, sure, you made some money, but. I was going to say, like, the Chicago term for it is terminal break-even, right? Of like, hey, eventually in these trades, sure, you made some money, but eventually you're going to come back to break-even, if not worse. You know, it's interesting. So I always, so I like going to Vegas and gambling, right? But I try and sort of narrow them out. But if I get a big win, I try and walk away from the table, which is kind of tough, right? Because the minute I do that, if it happens early on,

and then usually what my wife would do, like, well, go do something else, right? Or how about you just go gamble again? Because you're over here, you're hanging out and you just need to do some stuff. You're too bored, right? And then I end up back at the table and I lose it all. I give it back to the casino, right? And I kind of feel like the same thing happens with those folks is you start to think you sort of get lulled into thinking that you are very good at something because you did it like great the first time around and reality was just luck. And then when it comes time to like actually show some skill, because while you weren't paying attention, the whole dynamic shifted and your thesis on why you got it correct the first time

was 100% wrong. And you're sitting there trying to figure out, well, what did I do wrong? I'm doing the same exact thing. Well, it turns out you weren't even correct the first time. You just got lucky. It was a random occurrence.'t i personally don't ever envision a scenario what i would want to play that game i do think there is a scenario where i would want options exposure and that is my ability for something that i go i'm already longing to get even more exposure over time, right? Because it does allow me to leverage up. And maybe I'm thinking about that in the wrong scenario, but I think it gives me levered exposure of a certain particular entity. Personally, majority of the stuff that I do as a retail investor is pretty much all index funds.

Most people think on Twitter, I don't like index funds. I actually like index funds. I, I limit the amount of exposure to individual names and certain accounts that prevent me from going swinging too far left or right. And like getting into that casino mode and putting more in. Right. And typically those are like IRA or something like that, that I can only put a certain amount in per year. But I go on the micro cap side. Right. And those are the names that I go after because I always

get worried that now that I'm starting to get a peek behind the veil of how this stuff works, that I don't want to be on the other side of QVR advisors, right? Who are buying this stuff or BlackRock or whatever these giant institutions. So I go into stuff that they can't necessarily access with these larger funds. And it's mainly just retail investors, hopefully. But when I look at the options market, like for some of these names, it's like non-existent. Sometimes the value is like 10 orders. Right. Um, and I kind of feel like, especially after reading this book, another component that

people don't pay attention to is you actually need volatility in like, uh, volume to go across on both sides to even be able to get in and out of these trades like it's great if you identify something but if you can't get out of the trade it doesn't effing matter yeah absolutely i think you know one way to think about you know who are you interacting with in the options market um with with very high probability if you if when if you have an option execution you just trade it with a market maker, right? That's just kind of how it works. And including in micro cap names and that market maker might be a smaller Chicago firm or it might be Citadel Securities or Jane Street or whatever,

right? But those are the people that have bids and offers out even in those small, funny micro cap names where there's only a 20 lot you know, 30 cents at 90 cents or whatever, right. Is, is, you know, those folks have their universe of every single company in the world on they're listed on us exchanges and, you know, which have option markets and how wide should they be? How much does the stock move? How, you know, what are all the probabilities involved or whatever. Right. And, you know, when you, when you trade with them, it's because they think there's enough edge relative to theoretical mid-market in where you're open to trade that they're happy to trade with you. And that's the money that you're paying

them. And that's how they make their living. In much more rare cases, but occasionally, it'll be that our firm or somebody like us specifically wants to buy the options that you're trying to sell or vice versa. And we're out there bidding more aggressively than the market maker to try to buy those options. And that's kind of, you know, the case that you said, where it's like there's somebody that you're worried might be more informed than you that that's trying to that's trying to get that, that position. And by the way, that's the case where you're going to get a fill that looks like a better fill, because take that example of a pretty illiquid option. That's 30 cents at 90 cents, right? And mid market is 60 cents. It might be that if you get out there and you, you bid, you want to, you want to, so let's say you want to buy that option. It might be that if you get that, get out there and buy bid 75 cents or 80 cents. So a little below the offer. Citadel might still fill you because they're like, oh, well, that's still enough spread for us. We'll take that trade. Ben might fill you at mid-market at 60 cents if I actually want the other side of that position. The difference there is presumably I've thought about why I want to buy that option, whereas Citadel is not trying to, the automated market makers aren't trying to buy or sell a position and

hold it. They just want, okay, is there enough spread? Do I think I can get out? All that kind of stuff. And I'm saying there's almost no chance that Dr. David in Seattle is on the other side of that train. There's very little chance. It's possible that some other individual investor is like, hey, I want to buy a two lot of that option. But the probability that you're both trying

to do that at the exact same time is just pretty low, right? Speaking of probability, it's interesting to find out that majority of this works off of, you mentioned normalized curves, right? Specifically implied volatility is more of a normalized curve, right? And which is interesting because we always in math, science, medicine, whatever, everyone shapes these things to look like bell curves, but we know in actuality,

they don't actually resemble a true normalized distribution. And so I've heard, prior to reading this book, I used to always hear you talk about skew, like is it skewed this way or skewed that way? And I knew it from a mathematical standpoint. However, what does that actually look like in an everyday,

like how do you take skew into account when you're thinking about like purchasing a certain option? Sure. So maybe first, just to start with, you know, back up a little bit. So there's no assumption about normal distributions and anything related to options ever. That's important. And people get confused about that because they see Black-Scholes formula and they're like, this thing is a normal distribution. But again, back to the point where literally all that Black-Scholes implied volatility is telling you is just normalizing a price in a comparable way. And the whole point is that the at the money option where the strike price is right at the forward or at spot might be 30% implied volatility, and that 5% of the money put might be 35% implied

volatility, and 10% of the money put might be 40% implied volatility, right? So that's skew, the definition of skew, there's different measurements, but it's effectively going to be how different are the implied volatilities of options that are further out of the money versus closer to the money and in the upside call wing versus the downside put wing, right? And you could think of it as all of the option prices and therefore all of the implied volatilities for a particular maturity in a particular stock tell you completely of the implied volatilities for a particular maturity in a particular stock, tell you completely what the implied probability distribution of future values of the stock are at that point in time. And it has nothing to do with normal distribution. It is what it is in general. It's like some very fat-tailed kind of skewed thing that you could think of as like,

this is what the market is saying, the full probability density of where the stock might be in three months. And if you have a, it's, you know, if you have a intelligent way of coming up with, you know, your how your view is different than the market, then maybe that's a thing that's very hard to do. Right. But so that's kind of the first thing is that skew is literally, here's how implied volatility is different at this strike versus this strike versus this strike relative to the money. And what the full SKU curve across all moneyness points or all strikes is telling you is what is the probability distribution of that stock going forward? And then how do you take that into account? Again, you back up and it's like,

well, what are you trying to achieve? And then that tells you take that into account? Again, you back up and it's like, well, what are you trying to achieve? And then that tells you how you think about it. In our case, we think about things like skew. It gets very wonky, but skew tells you a lot about, or the economics of skew are all about how implied volatility tends to move as spot prices move. So if you think about the S&P 500, typically, okay, if the equity market is down, typically implied volatilities are rising. And if the equity market's up, typically on average, implied volatilities are falling. And what the shape of the skew curve does mathematically is it actually tells you what

the market is implying about how much implied volatility is going to rise on average if the equity market's falling and vice versa and that's something that you know we might we might see dislocations in or have a view on but like you know that's a not again to your point not something that anybody should care about except out of pure intellectual interest if they don't do this kind of thing i care about it it's more of an intellectual curiosity like for instance um when i see like um like these uh different curves and like uh like areas on the curve i always think about well what is the derivative of that right look like right because typically um and i and sometimes i i call it like velocity, right? Because it's

really just a change in something over a change in time or a rise of a run, whatever you want to call it. And sometimes I think it can be sort of a smoother transition to look at stuff as opposed to the choppiness and noise that occurs underneath. And so when I think about implied volatility, I'm like, that can probably be choppy over time. And so what does the derivative of that look like? What does that curve look like? That's the math I haven't really seen so far that sort of tracks these things over time is if there is an ability to actually extract some inference of where the market's headed from that? So in general, I would tell you there's very little information in implied volatility about where the market is headed, other than the most kind of obvious insights, which is that,

okay, if S&P 500 implied volatility is really high, it's probably because we're in the middle of a market crash. And then if you sort of think that ultimately the US is a place that doesn't fall apart and the Fed or the government or whatever kind of deals with the banking system or whatever is going on, then often historically it has been the case that if the market's crashing, then it's a reasonable time to buy equities or whatever. But I think that, and there are people who will tell you otherwise on Twitter, and we can talk about that.

But if somebody is like, look at this thing that I know about the Z-score of the slope of the skew curve, you got to buy stocks. Just like... Delete. No. Just delete. You got to auto- block those folks man you know i is it fair to say the implied vol tells you something about the demand for um below the

mark right if you have that skew and you have more implied vol on the downside is that saying there's more demand on the downside for those it does it it does mean that and then the question is what's the demand driven by? And usually it's kind of the fundamentals driving volatility in the market. So like, why is implied volatility going up? Well, because some combination of people are buying options because they got worried or because realized volatility is rising a lot and the value of options is a lot higher and it's a forward-looking thing. And same with skew, right? If skew is going up, so downside is getting bid

relative to near the money or upside, it means people are, large market participants are out some combination buying downside right now or selling upside. And there probably is a reason for that. And that doesn't mean that it's getting more expensive. Maybe it's actually getting cheaper and they should be buying more of it, right's no all of the obvious one very important rule of derivatives is there is no obvious wisdom right this like this thing went up so it must be a sale or you know implied volatility is low so it must be a buy or like all of that kind of stuff that you just see all the time it's all wrong and um and you should you know forget that you ever learned about any of this it's interesting that you say that right because like uh i've been i think i told you i've been reading a lot about uh churn followings is like the thing that i've really been looking into i

was reading med faber's paper it's more like a book i think 70 pages long but um i find it interesting so i do and like and maybe i'm completely wrong please correct me on this if i am let's say i'm looking at a certain sector and i see that certain names the options like a certain side of the options are starting to get very expensive and there's a lot of value going across for a certain timeframe. Let's just say it's six months from now. Am I wrong in making a educated inference based upon options call value or put value to tell me like, hey, this is where the generalized market is thinking that this is going to head. Right. And so taking a pitch, a position as a retail investor, which is easier in the underlying equity market. Is that wrong? I don't think there's any robust information in

looking at simple, publicly observable things like call or put volume in like the direction of stocks right and the world would be crazy if there was well i mean that wouldn't make any as a starting point well the world shouldn't ever expect yeah you shouldn't expect anything like that to be true robustly no the world is not crazy in that way the world is crazy in like unpredictable weird stuff happens that you haven't seen before and whatever the world is not crazy in the sense of it's really easy to predict what's going to happen to stocks and you can just kind of do that right well i don't i don't think i don't think it's a prediction though right because like we're talking about if if you have a hundred people in a room and they get asked a hundred questions that are yes or no right it? And they're common sense questions, right? The majority of the

people in the room, if they have legitimate common sense, but we know common sense isn't common, right? But they're going to answer the question on average the same, right? And so if you're saying that if the consensus from everyone, like the average consensus is in a certain direction, right, then the likelihood, you're more likely than not, if you are following the consensus, to be on the correct side, right? Now, there's over time, obviously, there's going to be instances where the consensus was 100% wrong, and whoever's in the contrarian group was correct. Right. But over time, that's going to happen less frequently than the consensus group being correct.

Like if I say two plus whatever is four, like you obviously know the majority of the group is going to get that correct. Right. four, like you obviously know the majority of the group's going to get that correct, right? So this is more of a, I don't really know what direction it's going, but there's a bunch of smart people who are thinking it's going this way. And if I follow the trend of the smart people, then more likely than not, I'm going to end up on the correct side. I don't think there's any evidence for that or reason to think that that's true. And I think the key conceptual insight is that markets are forward-looking and they price things in. So if we all think something, that's already in the price by definition that we did

those trades. It's not like, oh, we all think something and it's sort of likely to be right and it's not in the price yet. It's in the price because we all think it. And then when you go and look at historical data, there's a lot of different ways to do this. You can look at like just the smart people. You can look at like hedge fund positioning. You can look at all kinds of stuff following like the hedge fund position, smart, long, short equity positioning does not make you money, right? Like there's literally no evidence for this kind of phenomenon and you shouldn't expect there to be right. Because that's like the whole thing about financial markets. You have to think of, it's kind of like and you shouldn't expect there to be right because that's like the whole thing about financial markets you have to think of it's kind of like when you explain to you know like my mom like oh i saw this thing on tv about how there might be a recession does

that mean we're supposed to like not invest in stocks and like maybe maybe there's some very deep analysis you can do about how actually you have a very different view than like the consensus or whatever but like if there's something that you, we all kind of know about, and like, there's some view on it, like that view is reflected in the price already, just because you kind of know that something is going to happen and other people know that something is going to happen, like doesn't mean that then the price is going to change in some kind of predictable way, right? You see this all the time with macro and with market announcements and like people are always confused about it. It's like, you know, there's expectations about what the CPI number is going to be or whatever, right? And then there's all the commentary on like the range of places that it could be. And there's

the official forecasts. And then you could have the CPI number come out, you know, materially higher than what was supposedly consensus expectations, but like bond yields fall or whatever. And that's because actually like people thought that it was going to be, and they were positioned that way. Right. So like markets are forward looking and like, and not, I think the key way to think about it, it's not that market efficiency means like markets are right. Right. Like in any kind of deep sense, but what it means is it's not that easy to just sort of like have a good sense of some particular thing that's

going to happen or that some stock might be overvalued or that the CPI is going to do X and like therefore be able to make money on that in a reliable way. I think it's buy the rumor, sell the news, right? But then David, you might've been saying something a little different of like could you to me like trend following if i used option volume to identify a breakout of a new trend forming right yeah so yeah but that's what i mean it's like like the meb paper specifically looks at uh and per the paper 10 months uh simple moving average right that's that's relatively simple math right 10 months over that time average, right? That's relatively simple math, right? 10 months over that time series. And it looks at six months and all these other breaks down and it looks at these different asset classes. And my thing is just like, well, if there's, to me, the smart, super

smart money that on the institutional side, the smart guys like Ben Eifert, they're doing options and bonds, right? Because bonds is like the super smart guys like Ben Eifert, they're doing options and bonds, right? Because bonds is like the super smart guys that can price these things in their head. Yeah. So if I look at the trends that they're following, right, the trend in that market, is there a way to use that as a signal to reflect into the equity market. That was just the thing that popped in my head. Like, is that possible? Ben's saying no, politely. Yeah, Ben, oh, Ben tells me,

Ben knows that he can flat out tell me I'm an idiot and move on to something else. But, and here's the interesting point. I think it's worth, oh, sorry, go for it. I was just going to say, I do trend following all day, every day. Like the average, right in a portfolio of 70 markets, the percent correct of a trend signal is probably 26% or something along those lines. So a trend signal is more often than not three to one

incorrect. It's a false breakout. So just because all these smart people got into a trend doesn't mean the trend is going to persist. More often than not, it doesn't. It's a false breakout right so just because all these smart people got into a trend doesn't mean the trend is going to persist more often than not it doesn't it's a false breakout but they risk a very small amount on each of those false breakouts to and when they do catch it they ride it for weeks months years uh and that's how they overcome the right so the terminal effect is it's a it's a winning trade because they make more money when they winners, which are fewer than on their losers, which are more often. Well, so you just brought up a good point on the concept of risk management, right? Because that's really what risk management comes down, at least the way I'm understanding it based upon talking to all of you smart folks.

And I don't think from a retail perspective, that's something that gets talked about or really taught very well. We just get told just to put your money out there. And so what ends up happening is people go bet the farm on one thing and then they lose it all and they can't play the game anymore. You see that, I think, quite a lot in, certainly in the aggressive retail options speculation dynamic of the last few years. And we talked a little bit about it. I think it comes back to how some folks made tons of money, for example, on GME in January of 2021, and then gave a lot of it back. But I think options particularly complicate the risk management dynamic because options are more complicated, right? You'll have people who maybe have some notion of how much risk are they taking when they own a certain amount of equities, right? They're

like, okay, well, I have $100,000 in my account and I own whatever, I own $50,000 in equities, or I own a hundred, or I'm actually borrowing some money. I have $150,000 in equities. And maybe they can kind of handicap that risk effectively. How does that translate when it's like okay now i own you know option one week 10 out of the money option contracts on you know with what size and i think on like that's something that is very poorly understood by typical people who are like getting into options and they can lose a lot more money fast than they think because they're like hey look this is only you know i have options on a hundred i have a you know a hundred thousand dollars in my account i put fifty thousand dollars of it into option premium that's kind of like buying fifty thousand

dollars of stock no it's not you could just lose all of that like in three days right well there's a concept in there that nandenberg talks about, like different, like dynamic hedging, where if you aren't paying attention that you're basically going to go through your money very quickly because you keep buying, buying, buying to stay delta neutral, which I was like, why would anyone want to do that? like um and then it talks about like sort of selling off to sort of maintain your position but then it also comes back to what you talked about like you have to know why the f you're doing this to start with you always start with what is your objective and why right so i i mean a a market maker who gets lifted on some tesla stock is going to delta hedge it because they're what they're trying to do is they just sold this option and presumably there was some bid offer spread that they captured. And they're going to be trying to get out of that option. It's going to take them some amount of

time. They have some kind of portfolio of risk. Right. And they don't have any view on where Tesla is going. That's not their business. They don't know. They don't care. Right. They just want to be completely neutral to the direction that Tesla is going to neutralize that first order risk of the option position. If they get lifted on a call option, right, they're short the stock if they're short the call option. So now they need to buy enough of the stock back to kind of neutralize that move. Now they still have, that's still a risky position. They still have risk exposure in a short option, short call option hedge with long stock. It's a much less risky position than an outright naked short call option. Because if Tesla was just to drift up and you're short a call option, you're just going to lose a ton of money. But now their exposure is going to be to second

order factors like, well, how volatile is Tesla stock over what period of time? And again, they'll be trying to offset that within their portfolio by the ranges of different options that they might be long or short, and they're going to be trying to work that down over time, but they're absolutely going to Delta hedge. Whereas, uh, you know, a, a retail investor who likes Tesla stock and wants to buy the call options because they think Tesla stock is going to go up. Like, of course, it's not going to Delta hedge the stock. They shouldn't, that's not the point.

They're trying to buy that call option to get their upside exposure. So the world's greatest investor, Nancy Pelosi, likes to buy leaps and she's very successful at it. It helps to have the inside intel. That is also true. Why would someone want to buy a leap? If you're going to go long, why not just buy the underlying? Nancy Pelosi is just getting ripped off by her high-fee broker financial advisor. He was getting a bunch of spread on that is the answer right nancy pelosi would be making more money buying stocks than buying she's bought right like when you look at

those positions they're typically deep in the money long-dated call options which is something that you shouldn't you should never under any circumstances trade a deep in the money long-dated call option because the bid ask spread on that is very wide. You never bought like very deep in the money options are not liquid things out of the money and near the money options are liquid things. The nature of that position, back to put call parity, it's essentially the same as owning stock and buying a put option, right? Because with a deep in the money call option, it's like, it's mostly like stock unless the stock goes down a ton,

in which case you're going to lose a little bit less money being long the deep in the money call option. So as a starting point, if you want that payoff profile, you should be long the stock and long the put, not long a deep in the money call option. There's a lot of extra bid-ask spread

being paid to market makers and to exchanges and somebody's getting a big fat commission on that trade and that's why it's being done right because because actually she's not a sophisticated investor she's a very rich uh lady who's getting taken advantage of and don't feel bad for her by any means we don't even feel bad for Nancy Pelosi. I don't feel bad for her at all. But that's not smart trade structuring. That's somebody getting ripped off. And as we take away from this, I'm like, hey, retail, run away.

A lot of them will be like, cool, my advisor in Toledo is going to sell these call options for me, and I've got it figured out because I know I can't do it myself. So talk a minute, if you could, Ben, about that, of like, that person likely has no even better idea than you do. Yeah. And this is something that David and I talk about, right? So there's an important role, I think, in some cases for financial advisors. I think the important role there is really, ideally, keeping you from doing dumb stuff and helping you think about a plan for your wealth and your assets. And there's some compensation for that. And like, that's good. Giving you tax advice, you know, all the other kinds of things, you know, financial advisors are not options trading specialists and you shouldn't expect them to be, nor are they necessarily, you should,

you should, you even think of them as like stock picking specialists. That's not their job and that's not their, their, their role. Right. And if your financial advisor is putting you into a bunch of weird derivatives and options stuff, uh, the reason that they're probably doing that is they're getting paid big kickbacks on that from whoever is selling the product. And you should take that as a huge red flag. So here's my other question, right? Because there's a guy who is infamous on Twitter, Nassim Taleb, am I pronouncing his name correctly? Who has some interesting books that I've all read and I've quickly forgotten. But he talks about tail hedging, right? Which to me, like, kind of makes sense. But then it kind of doesn't hedging, right? Which to me, like kind of makes sense, but then it kind of

doesn't make sense, right? Because if you're constantly, it's like, it's like walking outside, right? Like we know that the risk of being in a car accident is actually, it's really, it's higher than what people think, right? But it doesn't stop us from driving. We just sort of drive, right? Because if you're really worried about getting hit by that car, you would never go or getting into an accident, you would never get in your car. So why would I pay for a losing strategy just to have protection against a once in wherever event. Now, I know the argument is that these like never events tend to happen more frequent. I think that's the other argument I've heard is like it happens more frequently than we actually pay attention to. But over time, how much money like does it shake out over time that you've actually not even broke even even when you have an asymmetric payoff?

So a great post thread on this. Yeah, but you can read all kinds of stuff that I wrote on this. So I think the first thing is we have to differentiate, should you actually be thinking about this and trying to do this as an individual investor is a different question, but let's just talk about the concept for a second. I think the right analogy actually, so what you said of like not driving your car, that will be not having an investment portfolio, right's not a tail hedging thing tail hedging is like buying your buying car insurance right so like you drive your car and you have insurance because you're kind of like well I have this nice car and it's like if I wreck it then that's going to be

70 grand and I don't really want to be out of pocket 70 grand and so like I'm going to pay an extra grand a year or whatever for, you know, right. So that's the analogy to, um, to, to tail hedging the, and then I think that the very short version, again, go, go read a lot of that stuff. Right. But the very short reason, um, version is, um, so if you think of an investor, they're going to have some kind of investment portfolio. Um, the, when the once every, whatever it is, five or 10 years where equity markets just completely massively melt down, the key question is if they have an efficient source of a lot of strength in their portfolio in that scenario. There's a very strong complementarity between the tail hedge and

the portfolio in that precisely when your portfolio is losing a ton of money, that's when the tail hedge is making a ton of money. And you can't actually, if you're thinking about the long-term performance of your portfolio and comparing just an equity portfolio to an equity portfolio with a tail hedge that you're rebalancing together with the equity portfolio, you can't analyze those two things on a standalone basis. The average returns of this thing plus the average returns of this thing do not equal the average returns of the portfolio because of the covariance effect between the two. And you can end up, so that tail hedge will always be a money loser on average over time, over long periods of time. Otherwise, the world would be crazy. And again, yes, the world was crazy, but not in that way. But the end result of the whole asset allocation, you can end up with lower risk making the same amount of money over time or more

money over time because of that complementarity effect. And it depends on lots of details and nuances and stuff. But there's sort of a fallacy in this thing loses money over time. Therefore, it shouldn't be in a portfolio. My portfolio will do worse within it. That's not a correct logical statement. Well, so how as a retail investor, do you even tailhitch? That's the thing that comes down, right? Because there are people who say, and I've mentioned this before, as a retail investor, you should be long only, right? But you also have risks that you need to worry out for or worry for, like how do you even implement a tail hedging strategy other than paying some mutual fund to quote unquote provide you that type of exposure or some

ETF, right? Like how is that? Is that a thing that retail investors should even be concerned about? I think if one in the position of a retail investor wants to think about this, I think thinking about some kind of ETF or fund product that does that and does it well and relatively inexpensively is the only way that you should think about it.

I think it's incredibly complicated and difficult to think about your equity portfolio and different things that you can do to hedge the tails of that portfolio and how you're going to do that and how you're going to rebalance. Most institutions can't do that at all, much less an individual investor. It's really hard. And so I think the right answer there is to look for what are the available opportunities to effectively get that, to get a portfolio that has a tail hedge attached, you know, via, you know, some kind of ETF. And there's a few things, you know, and there's a few things out there now. It's not as big of a marketplace as it should be. You know, Simplify has some stuff. A few other people have some stuff.

I think that's ultimately the thing to look at. Why do you say it's not as big of a marketplace as it should be? I think it's just a relatively new space and idea, right? That you kind of can buy an ETF that has strategies with options overlays in it and things like that, right? These things just haven't been around for that long and the first generation of a lot of like mutual fund products in the option space by the way were very terrible uh option selling funds that performed very poorly and had very high fees and the brokers were putting their you know putting people into part of it comes back to you know what we talked about with financial advisors and brokers, which is that the incentives in retail distribution of these

products are terrible, right? It's not like, what's a really good product that, you know, my client really needs. It's product pushing from fund companies and getting kind of retail dumb money in by getting, by paying middlemen to sell it to them. Right. And so that's kind of how you end up with bad and inappropriate and unsuitable them. And so that's kind of how you end up with bad and inappropriate and unsuitable products. And then you have, but like JP Morgan hedged equity, 18 billion or something, right? So you do have some big players, but I would assume you would think that's- Although that's not a tail hedge product. It's a good or bad, that's a collar product, which is in no way tail hedged, right? It's

selling out all the upside of the equity market by selling a call and it's buying a put spread against that. And it's going to have some kind of performance characteristics, mostly like just owning less equities with less beta, right? Which again, it's a thing that's a different thing than a hedge though. I think why it hasn't been as big is because of the reasons you mentioned. People don't still understand of like, why would I add this losing thing into this winning thing?

It doesn't make sense. i i'll dive more i think i read that thread before but i didn't have obviously that was like i think it was i forgot when i read that thread but like i understand more about these concepts now so i'm it's almost like we have this concept in surgery right so like if like if I'm teaching surgery, general surgery is five years, right? And so your intern years, your first year, when you, when I teach you how to dissect, right? You, your eyes can't see the fine detail. You just like, you're just overwhelmed. You're deer in the headlights, right? So, but then you get experience and then the next year your eyes change and you start to see a little bit more detail. Then the next year your eyes change some more and then you see a little bit more detail. I think the same concept has happened to me over time and that if I took David today

versus David last year, the amount of knowledge I've gained in that year is like David last year was a dumb ass, excuse my language, compared to where David today, because I read so much more and I talked to more people and I've gained. So like, I think going back to try and read more of the tail hedging strategies kind of, kind of will make more sense to me today, because one of the biggest things that I realized that I didn't really understand is like, um, the performance characteristics of different asset classes and the covariance or the variance in how they interact with each other, right? Because what you get told is, and I really hate this, there's the cultists of the boggleheads, hey, go buy this ETF that will give you this

exposure to this, and then you want some emerging market. So go get this international thing and then get yourself some bonds. No one ever talks about like, hey, what does the performance characteristic of this asset class do against this? We don't want them actually going in sync because then your portfolio is just going to go up and down like this. We actually kind of want more of a steady state and to narrow the variance of it occurring over time. But I think those are things that don't get explained to retail investors enough. Maybe it doesn't have to be, but then you have people like me that actually want to know, and then the information is not available. We're i would say by the way there's a lot of there's a lot of institutional investors that don't really think deeply about portfolio construction interactions with portfolios it depends there's a lot of institutional investors

that do but yet i think there's a a line of thinking i think that got very popular that was maybe in some ways a reaction to like what you would call the endowment model which was like really think about portfolio construction and do all this different kind of stuff which was well forget all that like let's just do highest conviction invest in like 10 stock pickers and they're the best bottom-up stock pickers and like over the long run we're long run focused that's all we have to think about. And I understand where people are coming from. And if you want to make an explicit decision to just do things really simply for a variety of reasons, like that's perfectly reasonable. But like the I think that way of thinking has caused a lot of folks to lose the portfolio construction intuition about how

different assets interact with each other. And the way that, the way that adding more things to a portfolio that act more or less just like the other things in your portfolio doesn't add very much versus adding things that are really complimentary. Finishing up here, this has been fun. Thank you. Let's get each of your hottest takes to finish up um ben i think just put his in an op-ed but tell us something you believe everyone else

thinks is wrong something everyone else believes you think is wrong that tom brady sucks whatever whatever your hottest take is what what is what is my hottest take i mean i think well certainly one of them and we already said it right right. But it's that, you know, the biggest takeaway from, you know, all of this kind of conversation, you know, isn't, isn't let's get really excited about skew. It's like, this stuff is intellectually interesting, maybe, and let's engage with it. But like, let's walk away from a, from a retail individual investors perspective from any notion that it's like, hey, I should like get involved with the space to like make some money

because I heard you could make some money in the space, right? I think that's just a very dangerous way of thinking. And it's like exactly what, you know, a lot of people on Twitter want to hear, right? But I think it's just to run straight the other way. Love it. David, what do you got? This is my time to shine, Okay. My time to shine. Okay. So let me start with the non-financial hot takes. I don't think they're hot takes,

but let's start with the non-financial hot takes. One, steak is overrated. Let's just make sure everybody understands that. Okay. I'm on the same page. I prefer a nice pork chop to a steak. Exactly. 100%. So steak overrated. Two, chocolate chip cookies are the devil to a steak. Exactly. 100%. Steak, overrated. Two, chocolate chip cookies are the devil's nipples. Stay away from them. Stay away from them. Three, a soft oatmeal raisin

cookie is the best thing you can do nutritionally. Keep your GI tract good to go. It's extremely tasty. A lot of sugar, though. It does have a lot of sugar though. It is. It does have a lot of sugar. So don't eat it a lot or you'll be coming to see me because you're going to be diabetic and I can take something out.

Right. Four, not everyone needs to invest in index funds. Right. And that's just the reality. A hundred percent of what you have to do does not have to be index funds. And I think the boggleheads are just as bad as the crypto whoever, as your Dave Ramsey, who are, they're all cults, right? The fact of the matter is in a cult I define as folks who refuse to believe anything outside of what they're doing is like, it can be possibly good.

So I will 100% never be on board with being part of a cult. I like index funds, but a hundred percent of what you have to do or whatever. And then three or five crypto isn't cracked up to what people want it to be and the narratives around crypto are 100 like ridiculous like the the fact of the matter is and i i take umbrage with this because just like insurance in the whatever um the african-american community was sold insurance constantly like we're one of the biggest buyers of insurance, right? Like life insurance. You talked to us about life insurance. It gets sold as an investment. Well, it turns out in the crypto community, guess who was buying the majority of

the crypto stuff? African-Americans, right? Like we may not have been making a ton of money on it, but my community got sold a lot on it. So as far as that, I'm not a huge fan of crypto. I think it does have some future application, but right now it's a bunch of freaking nonsense. Way to hear there's options on crypto. Oh yeah, don't even get me started there. Good times, you guys. Thanks, man. Awesome, thanks, David.

Hey, thanks. Thanks, you guys. Talk to you later. Bye. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel. Follow us on Twitter at RCM Alts and visit our website to read our blog or subscribe to our newsletter at RCMAlts.com. If you liked our show, introduce a friend and show them how to subscribe.

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