| -- | August 31, 2017 Odds on My D.C.  First, do yourself a favor and follow me on Twitter. Dry humor putting in new highs daily. The New York Times’ DealBook had a great piece of journalism a couple of days ago about short VIX carry monkeys. Well, that is what I call them. The Times is more charitable, calling them VIX day traders. It does a pretty good job of capturing the VIX subculture, up to and including StockTwits, which eggs all these guys on. The article features a former Target logistics manager who, by consistently betting that the VIX will go down, has goosed his net worth up to $12 million. He is in the process of raising $100 million for a VIX-smashing hedge fund. I probably had about 20 readers send me this article. They are very scornful of this guy. Is it jealousy? Not really. People who understand the dynamics of these products know that it is the definition of picking up nickels in front of a steamroller. About those nickels... Risk/Reward There are two types of trades: - You risk a little to make a lot.
- You risk a lot to make a little.
In gambling parlance, the former is “taking odds,” and the latter is “laying odds.” In a casino, generally people don’t like laying odds. Take the craps table, for instance. All the action is on pass line bets and hardways, where you can risk a little to make a lot. People are very scornful of the “don’t” bettors, who risk a lot to make a little. It’s worth pointing out that the expected value is virtually identical—it’s just a matter of style. The casino is not the only place where people are scornful of laying odds. The stigma attached to risking a lot to make a little goes back to the release of Nassim Taleb’s second book, Fooled by Randomness, in the early 2000s. It wasn’t as big as The Black Swan, but it was very influential in trading circles, and got people to think twice about selling straddles and going to lunch. Mathematically speaking, options are always a tad overpriced, so yes, it makes sense to sell them. But if you do it systematically, you run the risk of being exposed to a true black swan event—and getting carried out. The Day After A curious aspect of all the VIX sellers smashing vol is the fact that they are doing so while staring down the biggest-ever potential black swan—nuclear war. If we attack North Korea, and it goes sideways, the VIX isn’t going to 20. It’s going to 100. People know that deep down, but they think they will be able to “get out in time.” That is the liquidity fallacy—whenever you put on a trade, you must accept that the liquidity that was present on the way in might not be present on the way out. You could be “stuck” short vol at 10, and watch helplessly as it reprices to 100. That’s a bankruptcy trade. So, experienced traders know that this will come to a very ignominious end. But in the meantime, party on? As for the Target manager and his friends, you have to give them credit. They were the first to figure out that the term structure of volatility is nearly always upward-sloping, and when it isn’t, it’s not for very long. But the funny thing about finance is that it exhibits nonstationarity. There is no rule that says the term structure of volatility will always be upward-sloping. Maybe it will invert—and stay there. For years, bonds yielded more than stocks. Now the opposite is true. These sorts of things happen all the time. Mr. Target manager is probably feeling pretty smug. And why not? He’s made $12 million while everyone has been calling him stupid. He who laughs last, laughs best. That is an argument for cashing out and going back to managing Target. $12 million buys a lot of cool s---. Inevitable “Something bad is going to happen sometime” is not an investment thesis, but it’s true. Something bad will happen sometime. Could be really bad. If you’re a short VIX carry monkey, you are betting that nothing bad will happen, ever. That is verifiably a stupid trade. But it has worked for a really long time. And to some extent, it is a self-fulfilling prophecy. If you go in and smash VIX after something bad happens, you make it not bad. This happened Tuesday morning when North Korea flew a missile over Japan. The VIX smash ensued, and stocks rallied back to unch. It’s not sustainable. There was a paragraph or two in the Times article devoted to how complex (i.e., toxic) these products are, and how they are unsuitable for retail investors. I’d bet that most of these guys don’t know anything about option theory and haven’t heard of dynamic hedging. They only know that XIV goes up forever. If this really does blow up, there is going to be some soul-searching at the SEC. If you securitize something really complicated and then apply leverage to it of course people are going to trade it! People will always find a way to blow themselves up—it’s just a lot harder with stocks and bonds. The Daily Dirtnap Conference I haven’t yet mentioned this publicly—I am having a private conference for subscribers to The Daily Dirtnap on 19-20 October, in Pawleys Island, South Carolina. If you’ve ever been to South Carolina in October, you’ll know there is nothing better. I have seven slots left. I am opening it up to you guys. The pros: - Like I said, South Carolina in October
- An intimate setting, with only about 75 attendees
- You’ll meet some amazing people
- Zero chance you’ll leave without learning something mind-blowing
The registration fee is $775. It’s a very affordable conference, and you’ll be hearing from people who manage risk on a daily basis—not the usual folks off the speaker circuit. There is no downside here. It’s at the Litchfield Beach and Golf resort, which is about a 30 minute drive from the Myrtle Beach airport. If you sign up, I can send you tips on logistics via email. If you have some questions about the conference before you sign up, hit me at info (at) dailydirtnap (dot) com. Here is the link to register—remember, only the first seven people get a seat. Hope to see you there. 
Jared Dillian
Editor, The 10th Man
 | Get Thought-Provoking Contrarian Insights from Jared Dillian
Meet Jared Dillian, former Wall Street trader, fearless contrarian, and maybe the most original investment analyst and writer today. His weekly newsletter, The 10th Man, will not just make you a better investor—it's also truly addictive. Get it free in your inbox every Thursday. |
Jared's premium investment service, Street Freak, is available now. Click here for our introductory offer. Jared Dillian, former head of ETF Trading at one of the biggest Wall Street firms and author of the highly acclaimed books, Street Freak: Money and Madness at Lehman Brothers , and All the Evil of This World , shows you how to pick and trade trends, and master your inner instincts. Learn how to use “Angry Analytics” as a leading indicator of budding trends you can profit from… and how to view any market situation through the lens of a trader. Jared’s keen insight into market psychology combined with an edgy, provocative voice make Street Freak an investment advisory like no other. Follow Jared on Twitter at @dailydirtnap. Share Your Thoughts on This Article
 http://www.mauldineconomics.com/members
Use of this content, the Mauldin Economics website, and related sites and applications is provided under the Mauldin Economics Terms & Conditions of Use. Unauthorized Disclosure Prohibited The information provided in this publication is private, privileged, and confidential information, licensed for your sole individual use as a subscriber. Mauldin Economics reserves all rights to the content of this publication and related materials. Forwarding, copying, disseminating, or distributing this report in whole or in part, including substantial quotation of any portion the publication or any release of specific investment recommendations, is strictly prohibited.
Participation in such activity is grounds for immediate termination of all subscriptions of registered subscribers deemed to be involved at Mauldin Economics’ sole discretion, may violate the copyright laws of the United States, and may subject the violator to legal prosecution. Mauldin Economics reserves the right to monitor the use of this publication without disclosure by any electronic means it deems necessary and may change those means without notice at any time. If you have received this publication and are not the intended subscriber, please contact service@mauldineconomics.com. Disclaimers The Mauldin Economics website, Yield Shark, Thoughts from the Frontline, Patrick Cox’s Tech Digest, Outside the Box, Over My Shoulder, World Money Analyst, Street Freak, Just One Trade, Transformational Technology Alert, Rational Bear, The 10th Man, Connecting the Dots, This Week in Geopolitics, Stray Reflections, and Conversations are published by Mauldin Economics, LLC. Information contained in such publications is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The information contained in such publications is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in such publications are those of the publisher and are subject to change without notice. The information in such publications may become outdated and there is no obligation to update any such information. You are advised to discuss with your financial advisers your investment options and whether any investment is suitable for your specific needs prior to making any investments.
John Mauldin, Mauldin Economics, LLC and other entities in which he has an interest, employees, officers, family, and associates may from time to time have positions in the securities or commodities covered in these publications or web site. Corporate policies are in effect that attempt to avoid potential conflicts of interest and resolve conflicts of interest that do arise in a timely fashion.
Mauldin Economics, LLC reserves the right to cancel any subscription at any time, and if it does so it will promptly refund to the subscriber the amount of the subscription payment previously received relating to the remaining subscription period. Cancellation of a subscription may result from any unauthorized use or reproduction or rebroadcast of any Mauldin Economics publication or website, any infringement or misappropriation of Mauldin Economics, LLC’s proprietary rights, or any other reason determined in the sole discretion of Mauldin Economics, LLC. Affiliate Notice Mauldin Economics has affiliate agreements in place that may include fee sharing. If you have a website or newsletter and would like to be considered for inclusion in the Mauldin Economics affiliate program, please go to http://affiliates.ggcpublishing.com/. Likewise, from time to time Mauldin Economics may engage in affiliate programs offered by other companies, though corporate policy firmly dictates that such agreements will have no influence on any product or service recommendations, nor alter the pricing that would otherwise be available in absence of such an agreement. As always, it is important that you do your own due diligence before transacting any business with any firm, for any product or service. © Copyright 2017 Mauldin Economics | -- |
