RichardGibbons

Nobody said or implied that you don't understand any part of this. That said, you've made my point and my goal isn't to convince you of anything -- I've read almost every post on this board for 12 years and I think nobody's done that before. The thing is, you've mentioned this idea of obfuscating positions quite a few times recently, like it's some sort of breakthrough and a really good thing. It isn't. It's a very bad thing, because it increases complexity and introduces cognitive biases that makes you misunderstand what you're doing. I think there's value in refuting that model for other readers of the thread who might have less experience with options, so that they have a fighting chance of not ending up with a bad mental model. That's the point of my post. For what it's worth, you're not being misunderstood. You're just being refuted, but I'm not really expecting you to realize that. I'm simply expecting some others to.

Yeah, this is precisely what I meant when I said that it leads to cognitive biases. (In this case, it's called the Zero-Sum Bias.) Basically, you're illustrating exactly what I was saying, trying to rationalize that the decay loss in one is matched by the decay profits in the other. If you think the decay in the long option is a big problem, then don't buy the long option. You'll get to keep the profits that you got from the decaying short option. That said, it is reasonable to have a variety of options positions with different bullish and bearish bents in such a way so as to reduce risk in the portfolio. It's just a mistake to group them together in your head as a single position, since that's what introduces the cognitive biases. (Also I think one of the biggest novice mistakes with options is thinking that long options are bad because they decay, and short options are good because you profit from the decay. I don't think you suffer from that issue, but it is worthwhile noting it when talking about trying to "offset option decay".) Richard

In general, this is a bad way to think about options, since it obfuscates the situation and thereby encourages cognitive biases. Typically, decomposing the position is much more useful than mentally co-joining positions. If selling a put on SHLD seems like a good idea, it should be a good idea regardless of whether BAC options exist. If buying puts on BAC seems like a good idea, it should be a good idea regardless of SHLD. If one of these two legs doesn't seem like a good idea on its own, then the aggregate position could be improved by removing the leg that doesn't seem like a good idea on its own. Obfuscating the individual trades is a bad idea because it can make you think, for instance, "that option was free because I got the purchase price from selling SHLD options". The option wasn't free, because you're still spending cash that you could have kept as cash. Decomposing the position lets you better determine whether each leg is good, without the unnecessary additional complexity of the combined position. (Unless, for instance, you believe that the two positions should be relatively correlated, like BAC and JPM. But I'm assuming that you're using SHLD and BAC for examples because you believe that they're relatively uncorrelated.)

I used to be OK at chess. I beat a master in a tournament at one point. But I'm pretty mediocre now.

If XIV drops 80% in a single day, it will automatically be liquidated. This is the scenario I mean when I say it'll eventually going to 0. (I'm curious what happens if it gaps to over a 100% loss. I guess the fund company gets burned in that case.) I'm not sure if there are restrictions on the VIX futures movement. I'd guess not.

I'm also in XIV and SVXY (which is nice because it has options and it's fun to sell covered calls when the VIX gets low). It's worthwhile noting that XIV will at some point go to zero in a single day and UVXY at some point will probably go up ten times in a short period of time. So any investment strategy that involves those ETFs should be designed to be resilient to those sorts of events.

He should make significantly less than the average teacher. There's almost no leverage in the job, compared to teachers, since teachers can potentially have a huge influence on people when they are at their most impressionable and fastest-learning stage of life. That said, $100K is very low for people operating heavy equipment who actually care about making money. I know people who started that way, and through hard work/brains/luck had net worth in the 8 figure range within a decade. (That said, if he didn't want to make the sacrifices to do so, I understand that, and it was probably a good decision for him. Money is not even close to the most important thing in life.) All that said, I do still think $100K is a good salary. My only real area of disagreement is that I think there's more value to be had in incentivizing someone who has a huge influence on long-term life outcomes of hundreds of people than someone who uses a machine to move stuff around.

This is not necessarily true, because of rebalancing. The performance of a combined performance that is rebalanced periodically can exceed the performance of the individual components. e.g. Suppose that you have two investments, and you put $100 in each. Investment A falls 50%. Investment B goes up 50%. You'd still have $200. Supposed you then rebalance, putting $100 in to A, and $100 into B. If A then doubles, and B falls 33%, then both investments are back where they started. Someone who had just bought and held each investment would have a 0% return. However, because of the rebalancing, your investment in A is now worth $200, and your investment in B is now worth $66. Your return of 33% is better than either investment A or investment B.

The whole key to my volatility strategy is that the futures are mostly in contango, and therefore ETFs built by rolling one month into the next constantly lose money, and the inverse of those ETFs constantly gain money. The simpler of my two positions now is a ZIV long. As a result of contango in the medium-term futures on which is is based, I think it will deliver strong, but often bumpy returns. I think it will be comparable to the UVXY short, but less volatile, with fewer extreme outcomes, and also gives me the option of tax-deferred compounding for years. The more complex is long SVXY (basically the same as XIV), long way out of the money SVXY puts, selling 10% of the shares every time it goes up 20%, and buying occasionally as it falls when I feel like it. SVXY has a simple average return of something like 80% per year. However, the challenge is that there is a big difference between the simple average and the compounded average, because it will go to zero at some point, and will fall dramatically every so often. (e.g. look at the stock chart for XIV at the end of the year 2011. This sort of drop is a normal occurrence, not an anomaly.) So, I want to get those high simple returns, but not have my compounded average returns go to zero when, say, someone detonates nuke on New York City, and short term volatility doubles overnight. (I think it's very, very difficult for medium term volatility to double overnight, which is why I'm not so concerned about ZIV.) Therefore, the puts exist so that when the VIX futures double and SVXY falls to 0 in a single day, I recoup my entire investment. I'll also probably sell them after a long down-trend like the 2011 example above, because if the VIX futures are already really high, it's basically impossible for them to double overnight. There are a couple of other non-obvious negatives. First, if volatility is volatile, (i.e. SVXY bounces around a lot) SVXY loses money -- though hopefully not as fast as it gains from contango. Second, the futures are likely to go into backwardization (i.e. the opposite of contango where rolling futures hurts SVXY) when volatility goes very high. Thus, SVXY will constantly be losing money when volatility is high. So, there's the irony that, when volatility is high and SVXY is most likely to gain from reversion to the mean, it's likely also losing money daily from backwardization. And, when volatility is low, contango tends to be high and you'll be making the most money every day from contango, but it's also the time when you're most at risk of losing money as a result of reversion to the mean, and also when a disaster will have the most impact on your position. (That's one of the reasons why I have the sell 10% of every 20% gain rule. A 20% gain is most likely to occur when volatility is low and I'm greedy for contango, but the rule forces me to take some profits off the table, reducing my risk and providing gunpowder for when volatility increases.) It's also worthwhile noting that I haven't done these sorts of volatility trades for very long, so I don't know if it will work, but it seems plausible to me.

The decay from volatility is built into the option prices. For instance, back in June, when UVXY was trading at about $70, I bought 2015 $70 strike puts at the ask for something like $47. Clearly they were priced to include the various forms of decay from which they suffer. Now that UVXY is at $20, they're trading for 52-56, though I sold them a while back, because, while I still think these will almost always be profitable, I've since decided that other short volatility ideas are better, and I didn't want too much exposure to short volatility.

Sorry, my mistake. You seemed to write 10 about messages about how Buffett hated artists, using phrases such as "Buffett's theory of artists being a waste of capital". So, I thought you were confused about what Buffett was actually saying and were seriously suggesting that Buffett hates artists. Because of the preponderance of dialog about the artists/capital allocation, I didn't realized that your caveat was your key point. Sorry for the misunderstanding.

This is a gross misinterpretation of what he meant. He meant that because he controls great amounts of wealth, he's capable of allocating resources in ways that are stupid and not beneficial to society. He could have said "Dig holes, then fill them in", as Orwell said in 1984, and it would have had the same meaning. He was not saying anything about the merit of art to society. It's typically a mistake to assume that Buffett is saying something idiotic, when a reasonable alternative explanation exists. (i.e. I agree that if he meant to imply that artists should become surgeons, it would be idiotic. But he didn't meant that.)

These are all fair replies. That said, there's no intrinsic reason why a doctor has to work harder than a teacher. Or have more education, or have licensing requirements that teachers don't have. We could demand high quality and get rid of the teachers who can't make the cut. We could demand the same of our teachers that we demand for our doctors, but we choose not to. I wouldn't pay teachers more for the same work, but would for improved quality. I think the main point is that Finland's figured out what works -- abolish private schools and pay teachers well. North America is choosing another path that results in a significantly worse education. This seems to be an endeavor where I think it makes sense to look at the evidence of what seems to be working and adopt best practices. Thus far, we're choosing not to do so, and over the long term, it will result in a competitive disadvantage.

Hmm, so then if you just close all the public schools, and restrict school funding to the government, you've solved the problem. (Well, and kill tenure and union BS.) So easy! 100K -- which I think is a stretch for a teacher -- isn't a high salary after 20 years. What does a doctor make after 20 years? What does a partner at a law firm make after 20 years? Heck, 15 years ago I was making about that a couple years after graduation. Of course, you probably don't think teachers are worth that much. That's kind of what I mean by "respect and pay well".

I think that there's some value in looking at the evidence in Finland. Buffett's basically right. Effectively eliminating private schools and making teaching a respected, well-paid profession seemed to work pretty well there. http://www.theatlantic.com/national/archive/2011/12/what-americans-keep-ignoring-about-finlands-school-success/250564/

Sorry, I don't know how to fix the quote above. Sanjeev, can you do it? (Or delete it.) The huge flaw is that you're completely excluding one of the most likely theory for how the universe works, and pretending that it doesn't exist because it doesn't match your theory. It's fine to do it, in that Newtonian physics still approximates the world. But it's a limited model that refutes other theories by assuming them away. (Sorry for the rushed response. I'm about to go on vacation for a week, and won't have access to the internet.)

OK, so an argument like, "Stock always go up (provided we exclude from the sample set any stock that goes down)", or "Newtonian gravity represents perfectly the way the universe works (assuming we ignore the big or the small)", or "All swans are white (assuming Australia doesn't exist)". Basically, your proposition is built on asserting that the universe doesn't have any properties that refute your proposition. So it's kind of an approximate model for the universe with huge known flaws rather than actually trying to represent the real universe. Ok, in that case your proposition is true, other than the time issues boiler raises. (You could just go all the way and say that the intrinsic value of every company is zero, since, at the heat death of the universe, all stocks and all distributed earnings of those stocks would be worthless. But I'm guessing that you wouldn't like either. I kind of like that one though, because it says that the intrinsic value of every company is fixed and knowable, which is kind of cool.)

There isn't one past. Suppose at this moment you flip a coin. One universe is created where the result is heads, and one is created where the result is tails. Do it again. Now you have 4 universes. There are some parts of the past that are in common, and some parts where the past is not in common. The problem with your argument is that you're saying that when you flip that coin and it comes up heads, that means that in your universe, it was always going to be heads. That's not true, because the alternative universe, where it came up tails, is also your universe and also contains the same you. Each Ericopoly in each universe could argue that the coin was always fated to come up heads/tails, but it doesn't make any sense to completely ignore the other universe which is also you, and where the opposite result occurred. It's still you.

Ericopoly and Birdman, you seem to be making the assumption that there will end up being only one outcome. Why are you discounting the possibility that a new universe is created for every outcome? In that case, all IV estimates are true, in one universe or another.

I'm not really bearish. I was very bullish, but arguments on this thread have turned me into a moderate bull. I thought its moat was very robust, nearly as strong as Google. But now I'm thinking its moat is actually weak, since, despite there being passionate bulls on this thread who claim to know a lot about the stock, there haven't been many persuasive arguments for it having a significant competitive advantage. So, I've mentally downgraded it from a strong moat to a weak moat. Nevertheless, I agree with you that it would be nuts to short it.

What are you suggesting here? A company that has released a successful product is above criticism from anyone who has not had a successful product?

This is the core problem -- obviousness is being grossly underestimated particularly when it comes to software. If you express a problem to 10 of developers, typically only a few solutions will arise. Yet it's typically easy to patent these solutions. It's very common for two people to come up with the same solution independently. That's why the system is broken. That said, I wouldn't expect someone who makes his living from this attribute to buy into this argument, but rather say that almost everything is non-obvious.

The thing that annoys me about this is that Google has created a 3rd party API, but for now is only allowing 3rd party developers to create free apps without advertisements. That seems very short-sighted to me.

I think it's an interesting email. Definitely more perceptive than I was at the time. It wasn't nearly as clear to me that the iPhone was a game-changer. The other thing I find interesting is the areas where you were off a bit. For instance, the iPhone dominance only lasted a few years, and wasn't sustainable. Despite iPhone's success, only six years later, Samsung has the dominant phone and is the one pushing the boundaries today. The other interesting one is Apple TV, in that Apple's had this huge lead-time but is very likely to fall to Microsoft's next xBox release. It really goes to show that in tech, even when your prognostications are largely correct, it's extremely difficult to identify in advance something that will turn into a sustainable competitive advantage like that of Microsoft and Google.

It's not apples and oranges. That said, if you don't have evidence for that belief, but just believe it to be true, it's fine to say so. I was asking because I was curious. I see lots of covered call sellers saying so, but haven't seen evidence, and when I reason it out, it seems to not make sense. Boilermaker, I share your belief. The interesting question to me when thinking about it that way is whether it's more economic to sell the naked put, buy a call, or own the stock. Part of the challenge for me is that the more undervalued the stock, the more safety in selling the put, but also the more upside you miss out on if that put is never exercised and the stock quickly returns to fair value. In that case, the shares or long calls would be much more profitable. (e.g. most people were buying BAC calls or shares a year ago, and not selling calls).