The Poker Face of Wall Street - Review

I had an opportunity to read “The Poker Face of Wall Street” by Aaron Brown. After reading, I still couldn’t figure out whether it was a case of the man with the hammer seeing nails everywhere or not. However, there are some good insights into risk, chance and life, in general in the book. A few that I liked follow:-

Risk Rules:-

1. Do your homework – You must avoid unnecessary risks and, just as important, avoid taking risks blindly when they can be calculated….you must take risks only when you’re getting paid enough to do it.
2. Strike for Success – risk taking requires “Prudence and Courage; Prudence in contemplation, Courage in execution.” If you decide to act, act quickly and decisively. Go for maximum success, not minimum risk….”From this moment, the very firstlings of my heart shall be the firstlings of my hand.” – quoting Macbeth
3. Make the tough fold – “Your first loss is your least loss”….If the result of that calculation suggests that you are not getting sufficient odds to justify further investment, give up just as quickly and decisively as you began.
4. Plan B is You. The only assets you can count on after a loss are the ones inside You: your character, your talents and your will.

Quoting David Sklansky’s famous Fundamental Theorem of Poker:
"Every time you play a hand differently from the way you would have played it if you could see all your opponents’ card, they gain; and everytime you play your hand the same way you would have played it if you could see all their cards, they lose. Conversely, everytime opponents play their hands differently from the way they would have if they could see all your cards, you gain; and everytime they play their hands the same way they would have played if they could see all your cards, you lose."

A Brief History of Risk Denial:

1. All our financial products are pure, with no artificial risk added
2. It’s capital formation, not gambling
3. Traders are order clerks
4. It’s not gambling; it’s hedging
5. Insurance payouts go for sensible investments, while lottery winners waste their payout.
6. We’re not gambling, we are investing
7. The ups and downs of the stock market just reflect the ups and downs of the economy
8. Governments set interest and foreign exchange rates
9. Derivatives aren’t gambles

The author is contending the above all are myths.

Scanning for Options trading opportunities – quick tips:-

Parity – Look for a situation where strike price plus call price minus put price is significantly different from the price of the underlying

Verticals – Buying a call or put, and selling the same kind of option on the same underlying with the same expiry, but at a different strike. When a stock is selling at the midpoint of a vertical, the vertical has to be worth very close to half the spread.

Calendar – buying one option and selling another of the same type, with the same underlying and strike but a different expiry. Longer dated options are more valuable than shorter dated ones. The spread is most valuable near the current stock price and should decline in price for options at higher and lower strikes.

“Everyone is an opponent-not a vindictive opponent; just a decision-making entity maximizing its own utility function without regard for your welfare.”

“The ultimate scarce resource in cognitive processing is attention. Things are going on right now that we’re not paying attention to. Information is flowing all around us, ignored. The trade-off is between attention and memory. A court stenographer can record every word everyone says in court, while reading a novel, but ask her what happened ten seconds ago and you get a blank stare. Attention is the tool you need to get information. People are using unconscious strategies because they don’t have the attention to solve everything optimally. We can predict their actions using simple game models because they’re not paying attention, not because they are.” quoting Colin Camerer

Cost Inflation Index grows five-fold in 25 years??

My first alma mater the Institute of Chartered Accountants of India started a good service for its members. ICAI sends out a Knowledge Capsule to all its members who opt for the service. The capsule is a summary of headlines from the leading newspapers that may be pertinent in the practice of the profession. I find it a good service. This post is not about the service per se, though.

This headline recently caught my eye - "Cost Inflation Index grows five-fold in 25 years" ?? The author is someone I respect for his good writing in Business Line. I have enjoyed his articles while I was a CA Student in the late 90s. I still do respect the quality of his writing. However, the tilt of this particular article made me wonder.

I wanted to put it in perspective. A back of the envelope calculation would show that a 5-fold increase in anything in 25 years is less than 8% per annum (the spreadsheet would show 6.81%). 8% is close to the interest rate prevailing interest rates for India during this time period.

"In the first few years, CII grew only by single digits. The latest jump is of 22 points, from 497 in 2005-06. The biggest increase thus far was in 1999-2000, when CII vaulted by 38 points to reach 389."

These lines again made me wonder. Of course, the single digit growth in the initial years is a property of any price index. Since the base is low - 100 in 1981-82, as the article points out - the year-on-year (YOY) growth would be low too. That is a 9% inflation in 1982-83 would make the 1982-83 CII to 109. However, as the index grows in value to say 497, the growth would also be magnified. The 22 point jump amounts to only a 4.4% rate compared to the 9% in 1982-83. This should be good news, really, going just by this jump!!!! The 38 point increase in 1999-2000 is a 10.8% increase, not so good news. But compared to the 1982-83 inflation, it is only a 1.8% higher rate. It also would suit the prevailing conditions in the economy - the after-effects of the IT boom and all.

My interest in bringing all these numbers up is to prove just one point - it is the relative values that matter, not absolute. I have seen the same thing happen with the reporting of Sensex values as well. A 200 point rise in a day when the index is at 11000 is only less than 2% and is equal to an 80 point rise when index was at 4000.