Chess and Trade (2)

If both chess and trade are games, why we keep playing these games?

Obviously, playing in this level of chess tournament cannot be justified by the financial reward. Even the champion, an National Master, spend 2 days played 6 games to won the cash award of $1800. There was not much left if taking lodging and transportation cost into account. Retail investors spend a great deal of time conducting market research and monitoring their portfolio. Even they might make decent profit, but after deducting commissions to brokers and tax to Uncle Sam, the yield will shrink substantially.

It is believed that to achieve genius level ability takes about 10,000 hours of practice or 10 years. Grand masters take about ten years of training and practice, only Bobby Fischer did it faster in nine years. It is a disappointing fact that most of us won’t be able to become a master or a professional trader, no matter how hard we try. That seems to be a typical high cost, long term, but low probability investment, which should be avoided outright.

We mentioned in the previous post, Louis Dembitz Brandeis, an associate justice of the U.S. Supreme Court, predicted a gloomy prospect for retail investors. However, Warren Buffet said:

“To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

Here Warren Buffet’s emphasis is on the importance of high EQ (Emotional Intelligence). On personality development, chess games and investments offer excellent opportunities to improve observation skills, analytic skills, execution skills and ability and summarization skills. A high level chess players with high EQ is also very easy to excel in other areas. The founder of Grandmaster Capital Management, Patrick Wolff, is a grand master who won two US championships. He obtained Bachelor of Arts from Harvard University in Philosophy degree.

Let compare EQ requirements for a trade and a chess game:

(1) observation skills:
a chess: eg: That is straight forward. Which file is open? Which pieces are on the same line, a file, a rank or a diagonal?
b Investment: Does an event will influence our investment decision making? Such as: In Valley Fair Mall, Apple Store and the Microsoft Store are just across the corridor, we can clearly observe difference in traffic.

(2) analytic skills:
a chess: such as: How is the situation? Am I ahead or behind? Is my king safe? Are my other pieces safe? What is the most advantageous order if I have multiple ways of attack?
b Investment: eg: Is that event just a coincidence or becomes a confirmed trend? What was the market reaction? If I can take advantage of this opportunity, which stock I should choose as the vehicle? Are both fundamental and technical indicators cooperative? How long is the time frame?

(3) Execution skills:
a chess: Choose the safest way when you are advantageous. Be patient when you are behind. Always consider sacrifice, sometime even major pieces, to smash opponent’s defense.
b Investment: Take disciplined actions decisively, cut lose when necessary, do not dream a miracle will happen.

(4) Summerization skills:
Each trade should be recorded in the trade journal, analyze and review regularily. Avoid “step on the same rake twice”. Remember Dalai’s wisdom “When you lose, do not lose the lesson”!

Not everyone is suitable for trading, trading is a life long training of your mindset. Just treat every trade as an opportunity to exercise, so that we won’t make the same mistakes when managing more money in the future.

博弈与炒股[2]

如果炒股和下棋都是游戏,那么为什么我们乐此不彼?

下棋不能完全用物质来衡量。比赛的冠军,一位国际大师,花费2天时间获得奖金1800元,去掉交通住宿费用,事实上所得无几。散户花费大量时间研究股市,即使能够盈利,去掉commission和tax,真正到手的也不多了。一般认为,在任何一个行业成为大师级的人物,都必须花上10,000个小时,大约10年时间。不幸的是,即使花费了巨大的时间和精力,也只有极少数能成为投资高手或是象棋大师。典型一个high cost, long time frame, and low probability的案例,从投资的角度应该避免。

前文谈到美国最高法院大法官路易士·布兰戴斯(Louis Dembitz Brandeis)对散户投资者的前途严重不看好,而Warren Buffet却说 “要成功投资过一生不需要超高的智商,非凡的商业洞察力或内部信息。我们只需要有良好的知识框架来帮助我们正确的决策,和坚定的信念以防止这个框架免受情绪的侵蚀”。

“To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

Warren Buffet在这里强调的是高EQ对投资重要性。在人格成长上,博弈与炒股都提供了绝佳的反复锤炼观察能力,分析能力,行动能力和归纳总结能力的机会。一个高水平的棋手在别的方面也很容易出类拔萃。Grandmaster Capital Management的创始人Patrick Wolff是一位曾两获美国冠军的国际象棋特级大师,从Harvard University获得Bachelor of Arts in Philosophy学位后却进入了资产管理行业。

微观比较一下一个trade和一盘chess game:

(1)观察能力:
a.国际象棋:如:哪些file open?哪些棋子在一条file,rank或diagonal上?
b.投资:身边或媒体上有没有发生影响投资的事件?如:在硅谷Valley Fair Mall里,Apple Store和Microsoft Store仅隔一条走廊,可以清楚的观察到客流的不同。

(2)分析能力:
a.国际象棋:如:大形势如何?我子力领先还是落后?我的王完全吗?我的其他棋子安全吗?我能用后,象,马三个不同的子check, 那么对我最有利的次序是什么?
b.投资:如:这个事件是偶然还是已经确认成一种趋势?以往发生这种情况市场如何反应?该选择那个股票来投资?FA和TA指标如何? time frame? expected return?

(3)行动能力:
a.国际象棋:优势时选择稳妥的致胜之道,劣势则相机而动,必要时弃子争胜。
b.投资:当机立断,顺市时了结或rollup,不顺时按计划果断平仓止损,不要幻想奇迹发生。

(4)归纳总结能力:
每个trade都要用trade journal记录下来,分析原因,定期回顾。避免“step on the same rake twice”。记住When you lose, do not lose the lesson!

并不是每个人都适合炒股,炒股就是a life long training of your mindset。把现在每个trade当成一次锻炼的机会,这样将来管理更多资金时不至于出现同样的错误。这下我们就不需要别的理由了!

Chess and Trade (1)

A few weeks ago, I took my son to People’s Tournament held at Santa Clara Convention Center in the heart of Silicon Valley. There were about 190 chess players from California and neighboring states, including 13 National Masters (NM), International Masters (IM) and Grand Masters (GM). Not too far away, Levis Stadium, the home of San Francisco 49ers will be open in a few weeks. I suddenly realized there are too many analogies between games and investments. New York Stock Exchange (NYSE), NASDAQ, American Stock Exchange (AMEX) are the playground like Santa Clara Convention Center and Levis Stadium, brokerage firms like Fidelity, eTrade, Interactive Brokers are organizers of the games, like National Football League and organizer of People’s tournament, they packet a profit no matter who wins the game. Institutions and Market Makers are masters or professionals who have an edge, sometimes dominantly, over retail investors, amateurs and neophyte players.

Trading stock is similar to playing games. Traders should take serious consideration of the following factors when opening a position:

  (1) Players: Stock market and chess are zero-sum games with winners and losers. The sum of winners’ gain of utility is about the sames as the losses of the losers, the other participants. A seemingly negligible portion is taken as commission or registration fee. The player should understand who is your opponent to choose the right strategy.

(2) Payoffs:For each opened position, we need to understand Max Return, Max Loss and Probability of all situations, such as break-even and exit. For the chess tournament, all registration fees ($100 apiece) will be pooled as award for winners. The champion of the open section will grab a cash reward of $1800, a ROI of 1,800%. However, it is very very unlikely an armature player to prevail in that section: although he may win a game by pure luck, the chance of winning a row of masters is simply too low! That is exactly the same as hoping a windfall in stock market.

  (3)Strategies:In a chess game, we can have Sicilian Defense, or Ruy Lopez /Spanish Defense and etc as openings. In stock market, We can open covered calls or naked puts, or more complicated as butterfly spreads and iron condors.

  (4) Orders:After opening, we will adjust our strategies based on the opponent’s response. We can use Marshall Attack, Karpov Variation and etc in Spanish defense. In option trade, we can utilize spreads to rollover our positions.

A game plan is required to ensure a high probability of success.

If both trading and chess are sorts of games, then Efficient market theory seems won’t be able to applied to stock trade. Efficient market theory can be summarized as followings:

  (1)Every player in the market is rational. They are closely monitoring all assets in the financial market, conduct fundamental analysis, evaluate the share price of each company and allocate asset accordingly prudently.

  (2) The share price reflect the balance of supply and demand. That is, the number of players who think the shares is overpriced is approximately the same as the number of players who think it is under-priced.

  (3) Stock price can fully reflect all available information of the assets, that is, “informationally efficient”, when changes in the information, the stock price will surely follow changes. When a good news or bad news just came out, the stock price began fluctuate, when it has become obvious, the price of the stock has gone up or down to the right price.

“Efficient market theory” actually means everyone in the rational case, no one can beat the market in the long run. However, (1), (2), (3) does not seem to be true, especially in the player’s level. Masters (USCF National Masters need to achieve a rating of 2200) and Market Maker generally have after a long hard training, proficient at dealing with complex situations, rarely make a blunder. Most financial products do not have enough liquidity, and prices tend to be manipulated. Secondly, if you have the opportunity to compete for the World Masters champion, behind the coaching team will help master data collected opponent, a comprehensive analysis of the merits of their opponents, to develop corresponding strategies. Investment banking institutions tend to have a large team of analysts, focused analysis of each sector, a variety of asset, governments trends, including members of Congress to inquire into the attitude of the bill. Most retail investors won’t have the resource to match the professional players and are likely to be slaughtered in unfair games.

Louis Dembitz Brandeis, an associate justice of the U.S. Supreme Court once wrote:

“For a small investor to make an intelligent selection from these many corporate securities — indeed, to pass an intelligent judgment upon a single one — is ordinarily impossible. He lacks the ability, the facilities, the training and the time essential to a proper investigation.”

I am not saying there is no chance for an amateur to win a master. A master may make a blunder occasionally, but it is more likely he can survive and thrive after setbacks. Unlike stock market, game organizers like to divide players in different sections based on their levels/rankings. There are some asset categories. often associated with low liquidity and high risk, such as options and junk stocks, lack institution investors, but are Eden of retail investors. Please do not forget when you make huge profit, there is another retail investor might just lost his pants. The next one who lost his pant may be you and me.

The question now becomes whether it is necessary to spend myriad of time and energy to become a master. Or whether I can become a master even I spend myriad of time and energy.

博弈与炒股[1]

几周前我带小朋友参加加利福尼亚州的大众棋赛(People’s Tournament)。比赛在硅谷的中心Santa Clara Convention Center举行,来参赛的有附近几个州的190名棋手,其中有13名带帽子的,大师 (National Master NM),国际大师 (International Master, IM)和国际特级大师 (Grand Master GM)。看着不远处即将投入使用的旧金山49人队的主场Levis Stadium,突然想到炒股和体育比赛和下棋有许多相似之处。NYSE/NASDAQ/AMEX 相当于Santa Clara Convention Center和Levis Stadium, Fidelity/eTrade/Interactive Brokers相当于National Football League和People’s Tournament的组织者,机构大户Market Makers相当于这些带帽的master们,散户-散户是和我们家小朋友这样的青蛙们。

其实炒股和其他体育比赛一样,玩家在open position时必须仔细考量到博弈的几个要素:

  (1)局中人(players):股市和棋赛都是“多人博弈”的零和游戏,有赢家和输家,且输赢的数目相当,多的被exchange和broker抽走了。玩家需要清楚的明白对手是谁,才能制定正确的对策。

(2)得失(payoffs):炒股是需要明白Max Return, Max Loss和各种情况的probability,棋赛-本次比赛报名费$100,但MMs 免费入场!棋赛的reward跟参赛人数有关,本次比赛公开组冠军奖金$1800, 如果拿到第一,ROI是18倍!可是,一个未经过专业训练的棋手拿到最高奖的可能性就太低太低了!

  (3)策略(strategies):棋赛可以西班牙开局,也可以以西西里防御开局。炒股可以有covered call, naked put,也可以有玩花的butterfly spread和iron condor。

  (4)次序(orders):开局了,还要根据对手的变化,适时调整,如果以西班牙开局,还可以有马歇尔攻击奇戈林变例。玩option也可以根据形势用spread来rollover。

如果炒股和下棋一样是一种博弈,那么有效市场理论(Efficient market theory)就是无法实现的。“有效市场理论”包含以下几个要点:

  (1)在市场上的每个人都是理性的经济人,金融市场上每只股票所代表的各家公司都处于这些理性人的严格监视之下,他们每天都在进行基本分析,以公司未来的获利性来评价公司的股票价格,把未来价值折算成今天的现值,并谨慎地在风险与收益之间进行权衡取舍。

  (2) 股票的价格反映了这些理性人的供求的平衡,想买的人正好等于想卖的人,即,认为股价被高估的人与认为股价被低估的人正好相等,假如有人发现这两者不等,即存在套利的可能性的话,他们立即会用买进或卖出股票的办法使股价迅速变动到能够使二者相等为止。

  (3) 股票的价格也能充分反映该资产的所有可获得的信息,即”信息有效”,当信息变动时,股票的价格就一定会随之变动。一个利好消息或利空消息刚刚传出时,股票的价格就开始异动,当它已经路人皆知时,股票的价格也已经涨或跌到适当的价位了。

  ”有效市场理论”实际上意味着在每个人都很理性的情况下,任何人都无法长期beat the market. 但是, (1), (2),(3)似乎都不成立,尤其反应在玩家的水平上。
大师(美国 USCF National Master 需要达到等级分2200)和Market Maker一般都得经过长期艰苦的训练,善于应对盘中各种复杂的形势,绝少犯低级错误。大多数金融产品的流动性不强,价格往往被操纵。其次如果大师能有机会角逐世界冠军,背后的教练团队会帮助大师收集对手的资料,全面分析自己和对手优劣,制定相对应的策略。投行机构往往有庞大的分团队,专注分析各个sector,各种asset,各国政府动向,包括打探国会议员对各项法案的态度。不难想象大多数散户投资者成为机构slaughter的对象。

美国最高法院大法官路易士·布兰戴斯(Louis Dembitz Brandeis) 曾说:
对于中小投资者,以做出明智的选择,从众多股票中做出一个明智的判断 – 通常是不可能的。他没有能力,设施,训练,和充分的时间做适当的调查。

“For a small investor to make an intelligent selection from these many corporate securities — indeed, to pass an intelligent judgment upon a single one — is ordinarily impossible. He lacks the ability, the facilities, the training and the time essential to a proper investigation.”

与专业玩家博弈,不是没有机会,但笑到最后的很可能是这些MM们。体育比赛为确保观赏性,会把相同档次的玩家放在同一个section里 (玩家也可以交钱play up尝尝被虐的滋味)。这样在没有专业玩家的赛场上,每个都有公平的机会。一些流通性较低,风险较大的市场,如期权,垃圾股和问题股正式散户翻云覆雨的舞台。但请不要忘记当你make huge profit时,就有另一个散户被看到脚踝上。而下一次(或下某次)被砍到脚踝的可能就是你和我。

我们有必要花费巨大的时间和精力成为master吗?或是,即使我们花费巨大的时间和精力,我们能成为master吗?

Mid Term Call Strategy – Near The Money Call

We briefly discussed the short term strategy which utilizes DOTM (Deep Out Of The Money) Call to bet earning report. The stock can go either direction to certain level. Nevertheless, there is a option strategy to make a profit: We might long calls to profit from sudden jump, long puts to profit from plummeting stocks, long strangles or straddles, short iron condors to profit from drastic movement in either direction, or you might bet against no drastic, but no movement or mild movement by longing iron condors or shorting strangles/straddle. However, you should remember no matter what kind of setup you decide to take, your counterpart, very likely a market maker (MM), has already place the bid based on their sophisticated algorithm which is in favor of themselves. At the end of day. I mean at the end of market close of expiration day, MMs are likely the ones who profit eventually.

In the previous discuss of short term strategy,  theta (time decay) is the archenemy of DOTM (deep out of the money) near expiration call owner and the stock must appreciate rapidly. Theta can be found to describe the negative impact of time (i.e decreasing time value) pass to option price for both calls and puts. If delta is -0.80 (delta is always negative unless we can rollback the clock), which means the option will be devalued by $0.80 if other factors remain the same. The diminishing of time value accelerates when there is only 2 weeks left and race to the climax on the expiration day. If you need more leeway to allow your stock of interest to appreciate, you can choose Near the Money (NTM) Call which has approximately 2 months to expire. By that way, we will have sufficient time to ride the tide, but also have followup strategies when the tide is against us.

Each person has his own standard to pick stocks. I personally prefer the self-invented “3M” system to increase the probability of success:

1)Momentum: The underlying stock just breaks up and is in a confirmed uptrend, which is supported by favorable technical indicators and fundamentals.

2) Multiple non-correlated evidences, such as:

  •  The stock is recommended by Investors Business Daily and/or  Barron’s, such as it is on IBD Top 50 or one of the sector leaders.
  •  Phenomenon observed by myself, such as long line when dinning at Chipotle Mexican Grill, more electric cars on streets or in parking lots, more handbags of a brand, a full house of customers in Nordstrom, huge new job listing of your neighboring company (which usually means a M&A event might be imminent)
  •  Outperforming sectors:such as new energy, biotech and internet stocks of last year.

3)Market: We expect market will remain stable or maintain the uptrend. However, if there is a significant correction, most stock will go down with the broad market, no matter how pretty your chart appears to be.

We can purchase a high value, liquidated stock with delta around 0.5 and expect a ROI of 3-5 folds.

Here is a breakdown analysis of Greeks and I just assign an subjective probability value for simplicity:

delta: Let’s just assume we have a very nice pick and the uptrend will maintained. The probability of a winning delta is 80%.

gamma: The movement  (of either direction) can be accelerated or decelerated, P = 50%.

vega: If only consider the price of the expiration day, vega is not relevant.

theta: The time decay of the 1st one and half months are still manageable. Let’s just assume it will devalue 30%, or 70% favorable.

Overall, we have probability of 28%, not bad if we can gain 5x ROI.

Take home messages:

1. relatively low probability (not terribly low as DOTM),relative high ROI (not as high as DOTM),limited loss.

2. Followup possible: If the stock appreciates but time is running out, we can roll forward. If the stock is skyrocketing, we can roll up and let the profit run.

3. replicable, but ROI is not guaranteed. If we are successful one out of three trades (100% loss in 2 trades), we are only break even when we get 300% ROI on the winning trade. However, the probability of higher ROI will go much lower.

4. Not scalable: Except for those high volume liquidated stocks, Market Makers won’t allow you to purchase a great deal of NTM calls. They will lift the ask price when you are buying.

In essence, we can optimize our approaches to make right picks by refine our technical analysis and fundamental analysis, we can reveal more irrelevant events to predict the direction of the underlaying stock. However, we do not have the capacity to control the market and avoid adverse impact of an unexpected events. Thus, a prudent investor should have a sound exit strategy in mind before he press the buy button. Good luck!

 

Short Term Strategy By Owning Calls

We briefly introduced factors which influence the price of an option, such as delta, gamma, vega and theta. The value of a delta can be qualified as the correlation of the option and its underlying stock. If a stock goes up $1, and a call goes up 80c, and a put goes down 30c, delta of that call is 0.80 and delta of that put is -0.3.  The deeper the strike price goes into the money, the higher the correlation, approaching 1 for call and -1 for put. Thus delta of a call is between 0 and 1 and delta of a put is between -1 and 0.

It is generally believe that the market will remain bullish in the next couple of years, most stocks will follow the trend and go up. Thus, I would like to discuss the riskiest short term call “strategy” first.

Short Term (less than 2 weeks) – Bet Earning Report with Deep Out of The Money Calls

If you are right about the market response to an earning report, you may achieve 100 fold or higher reward. Today is July 24, 2014. Visa will release its Q3 2014 earning report after market close. Current price of V is $223 and its Deep Out Of the Money (DOTM)call option,  V Jul25′ 235 Call has bid/ask of 0.13/0.20, delta is 0.05,with unlimited reward and limited risk, that is $13 (use bid price) per contract. If V goes up to $224, the call will goes up 1 delta ($0.05), that is $0.18.

V Jul25 14 235 Call

IF Visa’s ER greatly exceeded the expectation and its share price went up 10%, that is $245. Congratulations! You will instantly achieve 100 fold ROI , that is, a single contract will worth approximately $1000  (intrinsic value is already $245- $235 = $1,  $10 X 100 = $1000). That sounds great, huh? However, what if its ER is great but market response is little bit lukewarm and V ONLY appreciated 5.5% to $235 by 4PM ET July 25 2014? I am sorry, all of the call became worthless.

Here is a breakdown analysis of Greeks and I just assign an subjective probability value for simplicity:

delta: Let’s just assume you are a stock guru, we have inside information, ER is fantastic and market responds positively (ER beat does not necessarily guarantee a positive market response). The probability of a winning delta is 75%.

gamma: The movement  (of either direction) can be accelerated or decelerated, P = 50%.

vega: After earning report is released, the uncertainty diminished quickly, which will cause the collapse of vega and the depress the option price. P = 10%.

theta: Very negative when it is close to expiration day. Since it is Deep Out of The Money (DOTM), the chance of the underlaying climb to the strike are quite slim. P = 20%.

Overall, the probability of profit based on my subjective probability is 0.75%. Actually, OptionHouse provides a probability calculator. The probability to reach the break even ($235.13) is 10%, and the probability to achieve 100 fold ROI is 0.5%. How is that? The probability is approximately the same as  8 heads in a row!

V Probability

Take-home messages:

1. Low probability, high ROI, limited loss with unlimited potential.

2. No time for followup actions: V Jul25′ 235 Call的bid/ask spread is 50%,  it will expire tomorrow (July 25, 2014). It is too costly and has no time to take sensible followup actions.

3. Non-replicable: It seems easy to bet correctly once, but it is impossible to bet correctly consistently.  Have you seen anyone who won lottery more than once?

4. Non-scalable: It is impossible to acquire large amount of these kind of DOTM calls. The maximum is $6760 for 338 V Jul25′ 235 Calls. When market makers (MM) see someone is accumulating, they will ruthlessly skyrocket the call price, this will definitely cut into your ROI.

Giving the extremely low P and high ROI,  shall we play it? Personally I redeem it more like lottery. We all buy lottery, but the goal of buying lottery is entertainment, not investment or winning a large lump sum. We won’t using our down payment to purchase lottery tickets or this kind of DOTM calls.  The DOTM call strategy can be served as a way of entertainment. With $13 a pop and an unlimited dream, it is not a bad game to play.

P.S: At 4:30 PM ET, V released better than expected earning report,but stock plummeted. It is very like the V Jul25′ 235 Call will expire worthlessly.