What's the benefit of these fancy financial instruments other than for someone who wants to enjoy a slower, higher stakes version of the roulette wheel at a casino (assuming the Boglehead wisdom that individual stock picking is about as reliable as that)?
Hey, this is a good question. I have worked as a professional options trader at a major investment bank, and I would answer this a few different ways.
1) Derivatives allow you to tailor your risk to the precise component of the market that you have a view on. If you think the stock is going to have a large move (either up or down) in the short term, it's tough to express that view in the stock. If you buy stock, you lose money on a down move. If you sell short, you lose money on an up move. So, you can buy short-dated put and call options together (nicknamed a "straddle" if they have the same exercise price, and a "strangle" if the put exercise price is less than that of the call) and you capture not only your view on what the stock is going to do, but also the timeframe in which you expect that move to happen.
2) Options cost less than stock, so you can lever your position. Let's say a stock trades at 100 and you want to buy a hundred shares. Ignoring interest, that position costs you 10,000 dollars. If it rallies to 110, you make 1,000 dollars, or ten percent of your capital outlay. But if you buy a contract of 50-strike calls, you pay around 5,000. If the stock rallies to 110, you make 1,000 dollars again, but that is 20% of your capital outlay.
3) Derivatives have more factors involved in the valuation, which makes them complicated. This is a battleground where smart people who are willing to work hard can find inefficiencies and make money. Stocks have more people looking at them, and are more simple, so they may not offer the same opportunities for profit depending on your skillset.
4) Options serve a tax purpose. If you have a long stock position that you have held for six months and profited from, but the company has earnings and you don't want to risk losing money on a potentially bad quarter, you could sell your stock and pay short-term capital gains tax. Or, you could sell calls to buy puts and maintain your stock without having to pay tax on your stock gains yet. If the difference between long- and short-term capital gains tax is greater than the cost of the options you buy, then you could be saving money.
Amazing to me that the "why is the title gender normative" comment has gotten traction, but you've been downvoted. The internet is strange.
Options make certain things tradable that were not previously tradable. As you already say, given only the spot, you can basically trade delta - will it go up or down. With options, you can trade vol - will it move little or a lot. With a basket of options versus an option on a basket you can trade correlation - will things move together or not. With CDS you can trade credit (separately from interest) - will a firm go bust or not.
And creating these markets allows for more informed opinion on what's going on.
Having said that, I think derivatives are overrated and fulfil few socially useful functions, and those are often fulfilled by the simplest derivatives, not the complex stuff banks like to peddle (because their fees are higher, yet hidden).
I had a similar problem during an IPO lockup and couldn't sell when the stock was at a high point. If you buy protective puts (for the collar), it would reset the long term capital gains clock on your long position. I would love to be wrong so I can regret/cry about it!
> If you buy protective puts (for the collar), it would reset the long term capital gains clock on your long position.
Yes, this is true.
However, it doesn't force you to pay taxes at the higher rate, only to wait longer before the lower rate applies. Once you dispose of the put, the clock resets. But if you continue holding the stock for greater than a year, then the only issue is that your dividends may be taxed more.
On a large-cap name, one thing that some people do is to use a well-correlated index or competitor for the hedge.
In your lockup, I'm betting there were some restrictions on hedging anyway, which may have prevented you from buying puts at all.
Some of these "fancy financial instruments" are not as fancy as you think. For instance, futures and options are a form of insurance. My great grandmother was a farmer and would trade derivatives to insure her crops for the season. Some trader in Chicago can trade this speculatively, but a midwestern farmer has a real world use for the product.
Derivatives give you finer control over the financial risks to which you’re exposed. So for instance, if you’re McDonald’s and you’re planning on introducing the Chicken McNugget, you’re exposed to chicken price risk: the price of a McNugget meal is sticky, so if chicken prices go up a lot you could lose a lot of money. One thing you can do is buy chicken futures to lock in the price; if chicken futures aren’t available you can approximate them with grain and soy futures, since the price risk of a chicken is mostly the price risk of its feed. Another example is if you’re a US-based company but do a lot of business in the Eurozone; you’re exposed to currency risk that you can hedge away with a swap.
It’s true that if you’re a small individual investor you don’t have much use for derivatives; you probably don’t have idiosyncratic risks in your portfolio you need to hedge away. But businesses and big institutional investors do.
>, higher stakes version of the roulette wheel at a casino
As an example, Mark Cuban used put&call options to lower the stakes of the roulette wheel.[0]
He sold his startup to Yahoo for ~$1.4 billion of stock (1999 stock price was ~$95) -- but he couldn't sell it immediately because it was locked up for 3 years. That's a long time for Yahoo stock to potentially double... or go all the way down to $0.
To protect his wealth and get around the lockup, he bought put options to limit his downside. He also sold a matching set of call options to offset the out-of-pocket costs of buying the expensive puts. Therefore, deliberately limiting his upside was the proverbial "price to pay" to protect his downside. His financial engineering reduced the vagaries of the volatile stock roulette wheel.
It turned out that not getting too greedy with a potential gains and worrying more about the potential losses was a smart move because as we now know, the 2000 Dot Com Crash happened and the 2002 Yahoo stock price plunged to just $8: https://www.theatlas.com/charts/B1RjK9Q_
Boglehead investing is generally the safe and correct pick for the average investor, but large corporations, hedge funds, banks, and so on, all require hedging.
A simple example is a corporation that buys goods in China and sells them in the US. This corporation does not want to lose money due to a poor USD/Yuan exchange rate, so they hedge that risk by buying a financial instrument that guarantees them a certain USD/Yuan exchange rate.
Does the average Joe ever need to hedge currency risk? No. But large institutions do. And this is just a single risk; hedging is not just used for exchange rate risk, but also for credit risk, interest rate risk, asset price risk, liquidity risk, disaster risk, political risk, and so on. Any kind of risk can be priced (see for instance, health insurance and car insurance for consumers, a mechanism by which large corporations price the bulk of consumer risk), and there are many trillions of dollars that belong to groups that especially dislike certain risks, and therefore wish to hedge them.
Put options are also useful if you are stuck with a large position you cannot unload right away, but would like to cap your downside.
For example:
Your tech startup was purchased by a large public company, and you end up with stock you cannot sell for, say, 3yrs.
You are not an insider and now just retired and have no insider info and you dont have restrictions on puts -- In this situation, you can hedge your downside. You can also do a zero-cost collar and hedge your downside funded by giving up your upside.
Limited risk in that for the short there is potential for an unlimited loss (-infinity), while for the put option the maximum loss is the premium (-100%).
But the option strategy is much riskier as a loss of -100% is significantly more likely under the put option than the short due to implied leverage, time value decay, etc.
There are people and enterprises with natural exposure to certain risks. They can use derivative positions to take an offsetting risk and zero out (or mostly negate) the risk that they're taking. For instance, someone who leases out farmland will collect rents that correlate with the prices of the main crops in the area. They can short the relevant futures contract and get offsetting profits if a crop price reduction drives down rents.
Let's say you run a business in Canada exporting goods to the US. You negotiate a price with a client up front, but only get paid when you ship an order a few months later. Clients pay in USD, so it's good for you when CAD is low and bad for you when CAD is high (because your USD buys less CAD, which is what you actually use to pay workers, spend on yourself, etc.) Also let's say it's the kind of business where you ship massive orders, but only a handful of times per year.
In the months between finalizing a price and receiving the cash, you're exposed to foreign exchange risk. If CAD goes down, you end up making more money "for free", but if CAD goes up you make less. In the long run, you expect these currency fluctuations to average out; the unexpected surpluses will go towards covering unexpected losses.
Now let's look at a financial engineering trick that can eliminate this currency risk. Let's say you buy some `call` options, and sell some `put` options on a CAD/USD fund. (Selling the puts covers the cost of buying the calls). Now, if CAD goes up--which is normally bad for you--the value of your call options also goes up and cancels out your losses on the shipment. If CAD goes down--which is normally good for you--the puts that you've sold grow in value and must be settled with the buyer, so this cancels out the surplus you made on the shipment. The net result is that the amount of CAD you expect to receive two months after signing a contract in USD is "locked in" based on the exchange rate at the exact time you signed the contract and simultaneously bought the options.
So far, both the naked method and the "hedged" method result in the same expected profit in the long run. But notice that in the hedged case, you don't need to carry extra cash on hand just in case your company is hit with 3/4/5+ bad orders in a row. You don't need an insurance policy, you don't need to carry debt, and you don't need to pay the interest associated with either of those. You might still need some extra cash lying around to cover for other unexpected risks like labor strikes, natural disasters, whatever, but not for currency risk. This money is now freed up and you can use it to build new factories and grow your operation. You've made your business more efficient without lifting a finger!
Now the beautiful thing is that on the other end of this options deal there's going to be someone selling calls and buying puts that has the exact opposite problem you have. Maybe an importer in Canada or an exporter in America who both benefit from a rising CAD. They too get to lock in a price and avoid carrying extra cash to cover for currency risk. You both ended up helping each other without having to expend any effort finding the other party, negotiating deals, etc.
Now think how much more efficient the economy gets when everyone does this. And this is just one technique.
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Regarding personal investment, you can likewise use hedges, levers, and other financial instruments to come up with a risk/reward profile that matches your particular life situation. As a very simple example, you can buy a "protective put" option at say 80% of the price of equity A. This basically acts as an insurance policy; you spend a bit of money on the put, but now you're guaranteed to not lose more than 20% of your investment. Why not just keep 80% of your money in a bank account and invest 20%? Well, to make the same return you'd have to find an equity B that's expected to return 5x what you're expecting from equity A, and that might not exist.
This is so cool. It's like the boy's king Arthur of finance. I get a fair few channels and podcasts on engineering and such, but I haven't found a lot of good approaches to financial topics. This is great.
I think he would be more offended on the general idea of risk model. His conclusion: we can't do it. Don't model risk. Set yourself up to benefit from our inability to do it.
If you are a large bank, I don't think that the regulator will take kindly to the statement that you don't model your risk since Taleb says it's not possible. Perhaps a more moderate position would be not to put too much faith in models. Or as Derman writes: "Models are only models, toy-like descriptions of idealised worlds... If you
listen to the models’ siren song for too long, you may end up on the rocks or in the whirlpool."
"If you want to know the value of a security, use the price of another security that's as similar to it as possible. All the rest is modelling. Go and build."
Buffett:
"Price is what you pay; value is what you get."[a]
Time horizons are important. Buffett's capital comes from insurance float. That's very long-term capital. He can afford to buy an asset and let its cash flows pay him back.
If you're balancing an options portfolio, on the other hand, shorter time horizons matter. If the stock pays back in 10 years but crashes in one, the ten years don't matter for the holder of a 12-month call option. Thus finding symmetries becomes more relevant than fundamental analysis.
I saw this guy speak at the yale club or something in midtown (NYC) in 2017 on risk modeling. at the time he was arguing that what the industry needed was a return to fundamentals and more intervention from traders ie the algos had run away. I haven't read the article but seeing as how he was one of the first mathematical quants on the street I wonder if this from 2003 is contrary to his opinion from 2017.
Here's his book. I haven't read it but it's probably interesting.
I was happy to see this because of my interest in the subject, but I can understand that the title is a bit off-putting.
A bit off topic anecdote: a few years ago, while floor trading was still important on the Chicago Board of Trade, I was getting a tour of the floor during trading hours and my guide, a very experienced commodity trader, pointed out a fellow trader that had made the largest trade in history; it was a woman.
The title subtly but still obviously implies that finances and investing are men's business, and not women's. I don't see how anyone can deny that.
I bet that many women reading this title that work in finance don't appreciate the title one bit.
The argument that it's just a joke is not acceptable, because this together with other 1000 similar remarks, or "jokes" or micro-agressions will make women choosing that field as inadequate over time.
This is actually a scientific fact, that people that are told several times that they are not able to do a task or don't belong performing the task will underperform doing that same task, when compared to people that are not subjected to that treatment.
Words are powerful, I wouldn't want my two daughters to put up with this type of bullshit growing up.
The thousand little things seem to be experienced on your end. That this makes you condemn an author for his choice of headlines - when you've said nothing about the substance of an article - makes it seem like you have no guy-group to hang with. Get one! It'll clear up the perspective the guy's coming from.
There are fields that are currently over-whelmingly dominated by men. If you are a man, and you are in these fields, it seems like women just don't want to get involved.
But if you start looking with fresh eyes you start to see again and again and again small things, apparently insignificant things, that all combine to say "Women aren't welcome here." This is a single, simple, tiny, apparently insignificant example, but it's utterly ubiquitous.
Your dismissal just makes it clear that you either haven't noticed, or don't care. It's a sobering thing to realise that there is just so much subliminal repelling of women from fields such as finance, programming, physics, mathematics, engineering, and more. If you start to listen to women instead of just saying "it's all in your head" then you'll learn something.
And it's horrifying. I always feel guilty that when I get tired of the fight I can give up for a while. But that's because I'm a cis-het white male, and the system is biased in my favour. Others can't choose to give up - and it's relentless.
vcf, it is what it is ... the interpretations, judgments and your subsequent reactions however are, as you are keen to explain intended to get others to censor value creators (the pdf, not the industry).
its probably you that should be happy for free speech more than he.
There's a lot of incel lurkers here, and they seem to coordinate their actions somewhere else. Typical up/down vote patterns start with sensible upvotes and then a torrent of jealous downvotes.
It is a form of dry pedantic humor. In early 20th century USA, there were a lot of instructional books marketed at children with titles like this... "A Boy's Guide to Fishing", and so on.
The author, who wishes finance students to remain focused on the fundamentals rather than getting lost in esoterica, chose a title that harkens back to these plain-spoken primers. I suppose he didn't stop to think that most of his audience wouldn't get the reference.
It's about as un-PC as "The Dangerous Book for Boys", really (which my daughter read without being noticeably triggered).
I understood the reference straight away, but that doesn't reduce how unfortunate it is when one of thousands of other titles could have worked just as well.
Especially since the contents don't continue with the 'boys' theme.
It would have been nice if the author had included Boy Scouts style line illustrations... I'm picturing a scoutmaster in knee socks and a kerchief on one knee in front of an easel with an options payout diagram.
I actually bought a French version of one of these books for one of my daughters, focusing on science. But after reading through it a bit it was clear that girls were just not part of the intended public, so it didn't go under the Christmas tree.
The book was nominally about science, but it had a clear second message that I didn't want my 9 year-old girl to receive, with dad's stamp of approval.
I hear you. One of my friends (female) is a physicist whose career has succeeded in the face of many of her peers telling her - repeatedly, for decades - that women can't be as good as men at hard sciences because their brains are just wired differently at a biological level (a traditional attitude in the field). It's pretty draining.
I just can't get too exercised about "Boy's Guide" level insensitivity. If my daughter wants to go to Wall St., she's gonna need waaayyyy thicker skin than that. The biz attracts assholes and predators; it's not exactly snowflake-friendly.
I mean, at least i-banks are no longer openly allowing charges at whorehouses and strip clubs on company cards, but stuff like this does go on:
To be fair, people on here would lose their shit if it had been called 'The girls's guide to pricing and hedging'. Interestingly it would be largely a different set of people.
Who cares? Stop trying to police everyone else's diction.
"Men (and boys) may scoff" because this kind of criticism is totally irrelevant to the actual ideas being discussed. I know from experience that just about any person (man or woman) who has done a trading job professionally has had to put up with way worse in the time required to learn how to make money.
And in "today's world," a lot of us don't care about the politics of jealous misandry.
> just about any person (man or woman) who has done a trading job professionally has had to put up with way worse in the time required to learn how to make money.
Whether or not this is the case, it shouldn't be, and little things like this title subtly reinforce a culture where it is ok.
Exactly, it's about the impact of thousands of these small comments and insinuations over the years have on a group of persons.
If a woman hears and reads this kind of comments over her life, she will end up believing that Finance is not for women and not even choose it as a profession.
The title is obviously tongue in cheek and meant to be light hearted. I mean the article's first sentence is "There is an unfortunate strain of pedantry..." And given that in 2019 you can't use the joking title "A boys guide..." to anything anymore, the world has become much more pedantic. Humor will no longer be tolerated if even a single person doesn't think it is funny.
Agreed, and it's disappointing that you're getting downvoted for pointing this out.
It's probably an attempted play on words based on guides for boys, but yes, it's pretty tone deaf for something published anytime in the last 50 years or so.
To be fair, tone is in the ear of the beholder. Not to be disparaging, but I see your comment and the parent comment to be tone-deaf. I think it's just a difference of perspective.
I agree. The only thing I can say in its defence is that it's from 2003. Not a million years ago but I'd like to think we've moved on a bit in 16 years.
It does in fact contain the word "man" though in a (normally) non-gendered idiom.
> rather abbreviated poor man’s guide to the field
edit: just realised that there wasn't a space between "poor" and "man". However, it seems from a quick google search both versions (separate and a single word) are used for this expression.
Is "the boy" a patriarchic stand-in for the word "child", or what? It seems like some kind of in-group slang. Reminds me of the British expression "old boy", meaning "man".
I am so glad several other commenters here have pointed out that boy's guides were fairly common and this is a cute reference to that genre of book. There were girl's guides too. It is not the least bit offensive nor meant to cause offense.
Were the girl's guides about the same things as boy's guides? By cute, you probably meant harmless. You probably didn't mean to say that gender roles are cute. I guess its harmlessness is up for debate. My position on the matter is that there's no place for socially constructed gender roles in this society, and it's not cute.
Girls guides were about the activities most girls were engaged in at the time, cooking, sewing, etc. You never would have seen a "Girls Guide to Shortwave Radio," for example, fifty years ago because practically no women were doing it. I am sure it would have delighted a small handful of girls, but that is not how markets work. You don't print a book if it is not going to sell.
I generally disagree with your position on gender roles, which I think evolve naturally and are not necessarily bad.
Articles with gender in the title tend to get complaints. If it has women, men, boy, girl, male or female in the title, there is almost always a comment complaining to that fact.
I think it would improve the comment environment if HN had a title policy against using gender in it unless the article is clearly focused on it and has something new to contribute on the topic of gender. A lot of article titles would benefit by simply removing it.
Ignoring gender and gender dynamics on social media will not solve the issue in real life, it will just further the perception that social media is disconnected from reality. In my opinion, it would do more harm than good.
