Is finance derived or discovered?

I've been on some rambling musings on the math/psychology/econ/finance and thus trading universe, so here's a bit of an incoherent glimpse:

I try to think of all these topics 3 dimensionally so these paragraphs can go in any order, and probably should be side by side and simultaneous, although we don't read like that.

Math: Derived or Discovered?
Before even getting into trading I think on this issue here and there, why do patterns in math reappear everywhere? Are pi and e just curve fit numbers or a core ratio in nature?  I think about back testing and overfitting to curves as that comes up most in trading, but is there a pi or e equivalent in finance such as a golden ratio for risk premium?

Finance/Econ =  Psychology
This is where you will probably leave me rambling in my cave, but entertain the idea:  Is econ and finance math, psychology, or both?  I firmly think that all econ is small or large scale psychological interaction between people.  Its about fear, trust, heard mentalities, and everything else in Tversky and Kahneman.  But what about the computers? What about servers trading with each other a million times a second, there is no fear there! The point I've brought up before and stick by is that all trading algorithms are built by people and firms who have risk tolerance and requirements, and embed all that human fear into their code.  The computer just executes what a human would if they could see, click, and calculate that fast.

Psychology as physics
Here is another point to write off, and it goes towards the final mystery that is the mind and its rooting in the real world and physics.  Our thoughts are just atoms flying around through the brain which is truly rooted in the real world.  Additionally some will say that all of your past experience, bias, anchoring, etc contribute to decisions you make without you knowing at all, so are those decisions free will?  From this many argue if free will exists because atoms can work predictably thus the basics in physics for our thoughts and soul should be theoretically measurable (although that technology for that is far away).  If you agree with this mind as atoms concept, then all the ideas we have collectively as people (fear, risk, greed) are somewhat rooted in physics and part of that real world out their waiting to be discovered, rather than invented or derived.

Finance as Nature
Ok now bringing it all together, if you agree with the previous points-  If psychology is an extension of physics, with human emotions rooted in the atoms that make up those thoughts, and finance is an extension of psychology because this is ultimately human decision making, then by our wonderful transitive property- finance is physics.  This is all probably the worst kind of underpass rambling but I think about it all the time when adding the short vol positions.  I'm taking on the fear and risk of others, was this avoidable in nature? Just like some fish latch onto others or insects have complex ecosystems with each other, was it inevitable in the human condition that people would naturally come up with similar risk and credit/debt models simultaneously?  Was this truly invented or just waiting in the potential of our brain structure to be found?  As I'm typing this I'm doing the Werner Herzog narration voice in my head.

I already know as I post this I'm instantly going to lose 5 twitter followers but that is the cost of staying true to real psychotic rambling and not just retweeting 10 #hashtags!

The great part about down days

A little action on 5/17- SVXY down over 18%.  I'm sure everyone was all hands on deck so I try to post these concept articles back when we have a little lull in the storm.  As I mentioned in the 'comparing to buy and hold,' that kind of 100% short VIX stock risk is apples and oranges.  My short puts with half the account in cash had me down ~5% (compared to the 18%), which may seem rough depending on your risk tolerance, but here is why I wasn't worried and I'm actually happy and excited-

• This is why we have counter parties.  If the bears don't get their day every once in a while, how do we have a market?  I was feeling a little sorry for the bears/ VIX longs when this 5/17 spike was over the very next day, as least give them a little longer!  This is like selling scratchy lotto tickets to addicts, you can sell them $100 in tickets but they have to get at least $10 back in wins to keep the rush going. 

• This is getting ready/ approaching actual entry points for more conservative short VIX strategies, where we can deploy more capital.  Again I'm astounded at the mental fortitude of traders waiting for VIX>20 as an entry point, I agree that is the highest yield type of entry, and I'm waiting for those as well to go all in, but I can't just wait on the hope that that condition will happen.  No investment system should have hope as a core strategy. 

An earlier "fundamental" investor version of myself would be concerned at a dip- "what did I do wrong," "what did I miss?"

To me this is the same learning curve as losing your queen in Chess-

As a beginner, you miss some tactic and your queen gets captured- complete mental shutdown-
You lose scope of the whole game (which is probably over to be fair), although I have seen plenty beginner games where they drop pieces back and forth and still miss huge winning chances.

Fast forward to having deeper tactical and strategic planning.  They take your queen, but that locks them into a mate in 3 which you already saw!  We are down a queen this turn, like we are down 5% today, but we are set to recover and use our cash position in higher implied volatility.

In terms of creating a core short VIX strategy, we accept big down days as inevitable, just like you plan out your next 4 chess moves which involve a sacrifice in order to force a win.


Finally heres a little Janet for Friday - Does anyone else like these or am I just keeping myself giggling?

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