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-

A Nat Gas/ wheel trade Odyssey

I thought I would share a little trade example of my "premium over everything" life philosophy: a nat gas trade which started out as a short put after it got crushed from the huge late 2018 rip which notably wiped out Optionsellers.com --->
"It was a rogue wave.... I wake up every morning trying to steer the ship..."
That was a case study in itself, where he liquidated all client funds before spot was even at or near his short call strike prices.

Back to $UNG... anyway after that rip and drop, here you see spot around ~$22 which was a multi year low/ semi support if you believe in that, and where I got in with the first short put .. the 21.5p for 33c , which was my target range of 15%+ annualized premium, and an additional ~4% downside to breakeven, already at extreme lows.
 While this is an actual underlying/commodity, this is going in with the short VIX mindset/ short premium at least.

Well it turned ugly quickly!



Over the next ~month we went from $22 to $18.50, a nice ~20% bloodbath..

And here is where a live example of the clenched wheel strategy comes in.  Again, for trades like this always leg in, giving the option to lower your basis as it murders you like the above.  The green lines are the short puts, from the trade date spot to the option expiration date and strike.

I was assigned several tranches from 21.5 down to 19, getting the average cost around $20 by July

Once I've averaged down til the July range, you see the orange lines for short calls, to start lowering the basis on my assigned stock position.  (some of these were 1 lots, some bigger, I just wanted to give the feel of trajectories)

The final rightmost short calls you can see targeting my avg assigned stock price which was only 19.50/ $20, meaning the last big rip up was unnecessary for breakeven, but a welcome kick in the face from the fates nonetheless.

All in all, a grueling ~1% profit over 4 months on a 20% bloodbath underlying...

The most important thing being I didn't need the last rip, every trade is centered around the assumption in no move for you in the underlying.
This applies to $UVXY short call spreads/condors, very close ATM covered calls on dividend underlyings, or ITM covered calls.

LIFE NEVER GOES MY WAY, so trade like it!  Maybe this philosophy isn't for everyone, but it works for my mix of nihilism, fatalism, solipsism, simulation theory-ism, and if you believe in "late cycle."

I hope this was worth it for at least one of you! I'm trying to be the change I wish to see in the world- post bad trades, many adjustments, perseverance! 99% of financial interviews are just ignoring the guest's last missed prediction and moving on... That isn't real life!  The wheel trade is the grueling metaphor for the actual grind.