Continuing with the Indexing Blackpill

 I wanted to follow up on my last post, going more specifically into the Index/Passive structure, mostly from Michael Green's work I've been following- put much more eloquently and completely:

https://www.youtube.com/watch?v=x-rJciYZmi0

https://www.youtube.com/watch?v=6SVEaK7eDNk

https://www.youtube.com/watch?v=L_8IBc6Euqc

https://www.youtube.com/watch?v=sMwg6fqseP0

In the wake of every market commentator yelling "it can't keep going up, P/Es are 1000, this is the biggest bubble of all time, etc" at some point we have to look for something more quantitative.  Unlike the yelling, Green's analysis is mathematical/mechanical:

Does Vanguard/Fidelity/'passive' get inflows? (any work retirement plan, heavily covered by lobbyists)

Then-> buy  (at any price)

IF (clients get redemption/ outflows)

THEN-> sell (at any price)

This is it. This is flows>fundamentals (or flows are fundamentals if you will). Note the largest market force does not have qualifiers/conditions (if(interest rates>x), if(SMA<x), if(P/E<x))

This feels like a revelation, where you watch the 'scientific community' looking up to the stars- "well, Zeus must be throwing those lights around, how can that one keep moving that way!"  Then Galileo walks in and just measures the movement with trigonometry... 

Like walking into 1400AD with an astronomy textbook, looking at markets now with flows as the main lens feels like my other favorite metaphor "this is water".

Now lets address the issue with the Fed/ raising target inflation issue, as the last of the "macro" commentators are pointing to the massive inflation era we are going to hit, which will be good for commodities, gold etc:

In the above structure of Vanguard as forced buyers/sellers- does SPY behave differently from a commodity? If industry requires raw materials to build/ oil to move etc, they are forced buyers at any price (with a lot of options structures/contracts locking in rates over time).  Vanguard is an industry that requires buying a certain commodity at any price to fulfill its mandate- the commodity is just SPY...

This is important enough to put in my pantheon of market blackpills:

1. Petrodollar/ US reserve currency status- vs "why is our military budget the biggest in the world? why can't we just spend all that on healthcare and daycare?"

2. Warren Mosler / "descriptive" MMT which shows the structural accounting of why debt ceilings don't matter in the midst of decades of goldbugs yelling about it.

3.Index/Passive flows

(a close 4th is the Jeff Snider Eurodollar system, that might go under US reserve currency for now)

So given this, what do we do? I'm even more committed to the ratio structure I described in my last post-

1. Targeting the biggest movers in the tech/call skew/meme bubbles with liquid options

2. Looking for spreads that are fading another 10%+ upside weekly move, with enough strikes to allow further legging in to higher spreads.

3. The ratio spread allows the potential theta to double as the spread moves 'against' you, while financing potential long legs to hedge/ scratch out of the week.

4. no downside risk/vega. 

(This is the most important part about the structure. From Green's work, the passive % of market control exacerbates both upside and downside moves, meaning the "sell at any price" component listed above implies crazier crashes/ V rallies.  In this spread structure I'll be getting burned on outsized continuations after rips up, but the important part about this is I will be making adjustments on green days when the market is working.  If you have the downside risk, your adjustments on crashes will be potentially when bid/asks are a mile apart or worse the market is not working- depending on your broker)

What scares me even more is Green's work on showing the decreasing to potentially negative alpha of short option strategies, leading to a potentially darker blackpill: the only approach to this market is long vol / long straddles.  (If you are more interested, please go through the above clips which include some slide decks)  

I'm not mentally ready for pure straddles yet, primarily from the mechanics of not having adjustments to make, and not being able to model any ROI based on some theta.   Who knows, I might eventually take the final pill and delete my twitter as the name has me locked in...

Let me know your thoughts on twitter-

More reconciling with buy and hold

(I'll open with a Janet in case anyone is here for that)

Another weekend Mosque killing, another gap up- Looking good for the Boglehead crowd-

Here is a fundamental question I have for the buy and hold believers:

...First some rambling though, this is based on comparing buy and hold stock (SPY for example) vs selling puts, strangles or buying covered calls, depending on your risk tolerance. (I'm scared to death of upside risk)
Selling puts or strangles is optimized for the underlying trading within the expected range, which is already something Bogleheads seem to expect, "average" market returns, compounded with dividends (to compare to covered calls), etc.
I'll break this down into the 3 cases of down, flat and up markets-

• In a down market, selling puts (or strangles), or buying covered calls give you a better downside breakeven than stock, whereas buy and hold stock is just max delta on the entire downmove.
• In a flat market, the short options clearly outperform the non moving underlying and crush dividends.
• Finally, in an up market the buy and hold stock has the chance to outperform (with unlimited upside :) ), yet it still needs a greater than "expected" move (1 st. dev.) to beat short options (depending on strikes)

Given all this, the buy and hold stock strategy is truly only aiming for greater than expected upside moves,

So why not just buy OTM calls? 

Maybe literally 0 buy and hold Bogleheads care, but I haven't seen this addressed by anyone so it makes me feel like I'm in my corner with my crazy pills.  

Yes I know this is simplified but between OTM calls, deep ITM LEAPS or anywhere in between, you are taking the same position with better leverage.

Just a Monday musing, please forward to a Boglehead so we can check reality!

Comparing to Short VIX Buy and Hold

  Shall I compare thee to a summer's day?

One of the big struggles with Short VIX is the comparison to buy and hold on XIV or SVXY, as most systems that involve signals, tactically entering/exiting, underperform.  Furthermore most of the systems that beat buy and hold from Quantopian, etc, are heavily curve over fitted, some involving straight up constant variables.

Thus one of my main bulletpoints/takeaways that I keep in mind is

 don't worry about XIV buy and hold!

When considering the massive downside risk, as well as the periods when you hit a profit target and get out/wait for reentry (such as the last ~6 months?), I think its helpful to almost think of buy and hold vs. short VIX options as apples and oranges. 

As with any option strategy, the yield curve is closer to the poker cash game graph of incremental growth over time, with big draw downs- which I mentioned in a previous article. 

I view XIV buy and hold as closer to a tournament poker yield curve, with flat periods (such as this length low VIX run we are in) followed by high yield spike periods.  To clarify, the slow dips in between "tournament cashes" on the left graph would be flat in a buy and hold strategy, as you would just be in cash with no risk during those periods. (Its a metaphor, work with me!)

To bring in a macro view- 
Many articles note the overall contraction in VIX, possibly as a result of how much trading has entered the space and could ultimately be warping it.  Another possibility is the increasing awareness of how much drag long option protection adds to a portfolio.  Or the most obvious belief that Mama Yellen will buy the dip before we are even able to.

Whatever the combined causes, as short VIX investors we must have a contingency plan for longer periods of low VIX, which a buy and hold strategy doesn't really account for.  Given that historically some of the most conservative short VIX strategies of buying XIV when VIX = 25, 20, or maybe ~16, you might only have 2-5 trades a year. 
To extrapolate further, would you be comfortable trading short VIX if you knew that the optimal trade was only once every 2 years? What about every 5 or 10? 
Where is the line where you say "ok, I will trade off theoretical yield for consistency"?  

 I recently learned chess GM Hikaru Nakamura has actually started options, and was glad to see someone else see across the domains of options, chess and poker.  For XIV buy and hold, I see this as giving up on chess because computers will always win.. don't let that stop your playing or investing! If you see computer chess as apples and oranges from human chess, devoid with fear, time trouble, self doubt, needing to draw, and more, then maybe you can extrapolate to short VIX buy and hold- a computer/model lives forever, so it doesn't care about consistency of returns, the psychology of draw downs, the self doubt of long periods with no open position, the pangs of disprized love, the law's delay, the insolence of office and the spurns that patient merit of the unworthy takes- I'm getting carried away.

Ok ok in summary- Trading is psychology, don't force another psychology on yourself if it doesn't help you!  Don't blindly lock in on "This strategy is useless if it doesn't outperform buy and hold" when they are completely different animals!  Short VIX is constantly evolving due to macro factors, and especially with the current contraction it is possible that buy and hold will be the underperformer going forward as no buy and hold strategy will be holding/entering with VIX in the 9 handle.

Ok now tweet at me for how wrong I am