03/01/2021 — Don’t Miss The Boat…Er Point
Just another pedestrian 600 point rally for the Dow Jones Industrial Average. Facetious as that last sentence may sound, there exists a bit of truth under the sarcasm.
Years of trading has inured me to the occasional violent down moves. The nature of investing and the ebb and flow of market gains and subsequent retractions presented themselves rather clearly on October 19th, 1987. Until everyone collected their thoughts in the aftermath of what was the greatest market calamity up to the point, the shape of the volatility curve looked a lot like it does today…but mirrored.
Besides the basic bell-curve distribution that governs much of an option’s price with respect to its underlying security, there are a few more advanced “levers” that allow the intrepid trader to really try and hone in on an option’s theoretical price. At a rudimentary level, option skew roughly determines which side of current price deserves more “weighting,” more “implied volatility,” more “cost.” Skew used to favor the call-side, or the upside. The idea was that in a bull market — like the one that existed in the years leading up to Black Monday — a call presented an opportunity to purchase a stock at a discount in the future, whereas a put was…well, not a call.
The Crash of ’87 changed that, turned it on its head in fact. Financiers realized that true value of optionality was to be found in the put. That is why today, many models still measure put skew in negative numbers. There are any number of reasons why a stock or a market might tumble furiously, but few why it will rocket upwards. So, it seems strange to become accustomed to fierce and frequent updrafts.
In an individual security, a merger, a legal settlement, a patent approval, these are things that might lead to sudden investor exuberance. I find it more difficult to find these reasons in a broader index such as the S&P or the Dow Jones. Planes crashing into buildings and global pandemics darken economic outlooks in seconds and their influence pervades every sector of the financial industry. However, as unfortunate as it might be, for the human economy even great gains in a few industries come at the cost of others, so widespread instant-prosperity never looms on the horizon.
I even understand a slow, creeping climb higher and higher due to factors like a zero-interest rate and leagues of newly unemployed Americans looking for any chance to replace lost income. Wild days of 2.5% gains in a bellwether index like the S&P’s seem to only have one explanation — people piling in out of fear of getting left behind. I wrong as often as I’m right, but I can’t come up with a reason for the “panic” up. I always understand why people panic to the downside. It’s not hard to grasp that.
If I were to tell the truth, I feel these pangs of regret too when I see the market on a dead run to the stars. Sometimes I bite, but most of the time I try and remain patient, remembering the value of the put. With our current societal and financial predicament the excitement makes me nervous. It was only just last March…
Maybe that will cost me in the long run. I don’t know.
