Sunday, July 19, 2020

Life Is A Negative Lottery

Being awaken by a phone call in the night is almost certainly a bad news event. At the least it is a wrong number that has disturbed your sleep. Unless you are the rare individual up for a Noble Prize, there are many dreadful bad scenarios about to play out.*

This is indicative of life in general where bad news typically comes as quick, acute shocks and good news develops slowly. One could say that life is constantly forcing us to essentially write (i.e., sell) put options. While insurance sometimes is available to mitigate these risks, to more fully counteract this exposure we should be prudently buying call options. 

Briefly, a put option is an agreement whereby the owner has the right (not the obligation) to sell something at a predetermined price usually on or before a specified date. By writing or selling a put option one takes on the obligation to buy at the price the owner can sell at. Think of it this way: If you sell me a put option on a barrel of oil that expires in one month, I can exercise this right any time in the next month** to sell a barrel of oil to you at the agreed-to price (let's say $40)--making you buy it from me at $40. If I don't currently own a barrel of oil, I simply go on the open market, buy it at the current price, and then sell it to you at $40. The lower the price, the better it is for the owner (me in this scenario) and the worse it is for the writer (seller, you). 

A call option is just the opposite in terms of the obligation--it is the right to buy at a specified price whereby the writer (seller) has the obligation to sell at that price. Imagine having bought a one-year call option on 100 shares of Tesla stock a year ago at the then current market price. On July 22, 2019 TSLA was going for about $255/share. By July 17, 2020 it was priced at about $1,500/share. Suppose you bought this option (right to buy at $255) for a cost of $5,000, and consider that the value of the call option right now would be about $125,000. That's a great outcome for the option owner and an awful outcome for the option writer (seller). 

Here are some examples in life of put options where we are the unfortunate, forced writers (sellers) and potential call options where we can be the prudent buyers. 

  • Flat tire, car wreck, . . .
  • Stomach bug, a cancer diagnosis, . . .
  • House fire, termites, . . .
  • Tripping on the sidewalk, bumping one's head, . . . 
  • Tornado, flood, . . .
  • [this list could go on and on]...
  • Nurturing good relationships and broad networks
  • Maintaining a diversified investment portfolio added to regularly with constant market exposure--long-term compounding is the call option (outsized upside) aspect of this
  • Putting a small but meaningful amount of money invested in esoteric opportunities like Bitcoin, a creative person's far-out idea/business, . . .
  • Embracing a willingness to try new things and keep all options on the table (including the option to walk away)--for example, just a slight geographic expansion in one's willingness to relocate can have a large impact on their employment options
  • Learning diverse skills--good for career options, building networks, and knowing something that randomly comes in handy for the right time/right place
  • Not burning bridges; rather err on the side of putting oneself "out there"
  • Buying risk when others are risk averse and in increasing proportion to that aversion
  • Playing the lottery? Maybe, but...***
Find ways to disproportionately gain when things go well. Admittedly this is difficult as the opportunities are fleeting, rare, and easily outnumbered by fakes. Still, it is a very good way to improve one's holistic life portfolio. Perhaps the bottom line is when faced with two roads, take the one less traveled when the downside of each is close and the upside of the less traveled is high even if unlikely. 

*We don't even notify people of the Shazam Prize this way, or any way quite yet--coming soon.

**Technically this is an American option. A European option allows the transaction to only take place at the point of contract expiration. Effectively they are nearly identical in capital markets since one can always replicate the American option using a combination of European options or selling the European option to someone else.

***In most cases playing the lottery does not qualify under the prudent consideration--sometimes the expected value is actually positive, but the chances of a significant win are still mindbogglingly small. Still, $5 every once in a while (can you live up to that limit?) is a pleasurable escape from reality. My advice is simply to soak in the fantasy of what winning would be like considering also the downsides (change of lifestyle, lost friends, inability to trust many people, etc.). Perhaps to keep oneself in check, you should deliberately NOT play the lottery and accumulate those unspent funds in a separate account looking to its growth as a proud joy.

Saturday, July 18, 2020

The Wisdom of a Small Child

From about the time he was five years old, my son Max had four favorite sayings/shouted responses: 
He always has said them emphatically and authoritatively. And he doesn't back down. 

I have had this post in my notes for years (he will soon be 11). Although I am late in posting it, it remains true and relevant today. He has added to his repertoire
  • No, Dad, that's not how it works.
  • Look, just let me do it.
He has a point in each case that I really can't argue with. In fact, these are probably phrases we should all employ more often, if only with a bit less volume. Let me explain.

It doesn't matter - this is true for most everything. I don't mean so in an extreme philosophical sense of if you take a long enough perspective, it all fades into meaninglessness. But I do mean that a longer-run and bigger-picture perspective is the right approach. Most things in the here and now just don't matter too much. Go with the flow of life. If almost every problem is essentially small, the proper response is generally essentially modest. 

Quit rushing me - this relates to most things not mattering. What is the hurry? Rushing introduces added risk of error. How often are we neglecting this cost for some illusory goal of doing it faster? If it matters, it can wait. If it needs haste, speed will naturally follow. Perhaps we who realize a particular need for urgency need to inform others who are unaware or impress upon ourselves this demand, but the slip from alert to panic is a quick one. Almost nothing is actually on fire.

Quit wasting my time - time is our most precious asset. In a sense it is essentially the true unit of account. How much time a given action or inaction requires is a very underappreciated cost. And we only vaguely are aware of the value of our own time much less the value of someone else's. Our tolerance for wasting another's time or another wasting our own should be quite low. Our tolerance and appreciation for someone guarding preciously their own time should be quite high. Be polite, but don't let time be wasted.

Is that really necessary? - If it doesn't matter (usually to a large degree) and we shouldn't be rushed and we should not waste time, this question becomes imperative. So many times were these phrases shouted back to me as I struggled to get him to put his shoes on (among so many other similar trivialities). Getting the shoes on was necessary but . . . it kinda didn't matter, I didn't need to rush him, yelling at him do it rather than helping him wasted everyone's time, and none of that was really necessary.

No, Dad, that's not how it works & Look, just let me do it - I'm glad he is outspoken and very eager to try things for himself. He will make many, MANY mistakes in this journey. But I owe it to him to allow him this dignity. 

Thursday, July 16, 2020

What Explains The Low Death Rate of COVID-19?

Perhaps that title has you scratching your head, or perhaps it has you filled with indignant rage. In any case your first question should be: low in comparison to what? 

There is good evidence about how low the risk is for some (young especially but middle-aged and otherwise healthy in general) and how high it is for others including the very old. 

What I want to do here is put down my current assumptions about what is driving the death rate from COVID-19. These are not just subject to change, but I plan to revise my thinking (whether or not I get a chance to formally update this post or make a similar future post). I invite the reader to do the same--putting down one's thoughts in precise numbers is a very good exercise for cutting through shallow thinking.

Let's start with the assumption that everyone who gets COVID-19 will die from it and everyone will eventually get it. Let's limit this analysis to the United States. Formally stated:

probability(Death) * probability(Infection) = 100% * 100% = 100%

We know those two probabilities are not true (at least not yet!). So what is mitigating against each? Below are my thoughts on the factors reducing each including the amount they reduce the probability. Keep in mind these are for the average case. Obviously there would be greatly differing answers for various subgroups, and the answers would vary greatly over various periods such as March versus July of this year. Also note that I am simplifying the math by assuming the factors are mutually exclusive, which assumes that a factor is assigned responsibility (the associated percentage) when it is the dominant factor (e.g., While a therapy and general healthiness might help to save a given patient's life, if it was in fact the patient's own T cell immunity that was the most important factor, T cell immunity would in that case be assigned as the decisive factor.).

Limiting factors on p(Death):
  1. General healthiness = 50%--which, again, is to say that general healthiness reduces the death rate by 50%.
  2. Therapies (not including a vaccine) = 15%
  3. T cell immunity = 15%
  4. Virus weakening over time to be less potent = 10%
  5. Other natural immunity = 9.5%
  6. Residual (i.e., an infection does result in death) = 0.5%
(Note: I have not included a vaccine since one does not yet exist.)

Limiting factors on p(Infection):
  1. Good hygiene (active resistance to introducing infection) = 20%
  2. Personal preventing factors (natural resistance to infection) = 20%
  3. Social distancing (voluntary & intentional as a change from baseline normal behavior) = 20%
  4. Natural physical isolation = 15%
  5. Virus mutating to become more/less contagious = 10%
  6. Government-imposed lockdowns = 5%
  7. Residual (i.e., one does become infected) = 10%
(Note: The virus mutating to become more contagious could mitigate infection if it meant a faster burnout before 100% population infection. The virus mutating to become less contagious could mitigate if it meant that it changed the baseline for the other factors such that they were now more effective.)

The product of the two residuals gives us the population death rate. 
Residual(death) * Residual(infection) = 0.5% * 10% = 0.05%
This implies I am predicting 0.05% of the U.S. population or about 165,000 people will die directly from the virus. 

The ultimate accuracy of this calculation is not in any way my aim here. Rather I want to be constructive and precise about what I believe is actually driving the pandemic outcome. So it is the list of factors, which I very well may need to revise to at least add some or clarify existing, and the percentage share contribution I assign to each.

Notice that I believe lockdowns and their ilk, which could be construed broadly as involuntary, coerced social distancing, are responsible for a very small decrease in infection rates. However, I believe they have a very large economic and human cost (reduced happiness, reduced liberty, reduced agency, reduced dignity, reduced wealth, reduced health otherwise, et al.). 

Updated (7/25/20): I am seeing more and more evidence that the IFR may be lower than my estimate of 0.5%. If so and if the death level remains where it is today (about 150,000) growing less and less, then that implies the infection rate is higher. For example, at 150,000 deaths and an IFR of 0.5%, infections would be about 30,000,000. If the IFR is 0.25%, then infections would be about 60,000,000 or about 18% of the U.S. population. As for where I am wrong in the IFR, I have no guess--even though it is a factor of 50% perhaps (0.5% should be 0.25%), MAGNITUDE MATTERS! Any single factor is in that case just slightly off to get that new residual result. As for the infection rate, I can make a meaningful guess (and so can you disagreeing with mine for sure). I would guess social distancing explains a lower amount (e.g., 20% becomes 10% or so).

Friday, July 3, 2020

From Hong Kong With Love

We stand at the precipice of a great opportunity. The government of China is doing what governments do by going state on Hong Kong. The leaders there correctly perceive HK as a threat to their power and way of life. While I continue to predict that in the long run HK will eat China rather than the other way around, there are alternatives.

Many are suggesting a policy tool to challenge Beijing is to open borders to HK emigration. This is a classic tails we don't lose, heads we win situation. To wit: If China balks, HK keeps its autonomy and the progress of freedom marches on; if China digs in, we get a giant gift. I'm sure you can see the first case, but I expect the second case is a bit harder to swallow. Allow me to explain the benefits of Open Borders with this extreme example.

A few years ago I had the pleasure of visiting HK. Although I was fairly familiar with it, I was still completely amazed. I look forward to one day returning. At the time I planned on doing a post about the HK economy in comparison to my native Oklahoma economy. Unfortunately, I didn't get around to it, but I think I can quickly summarize one of the economic points I wanted to make: 

Hong Kong is 138% more productive than Oklahoma and most of that difference is because of population. The average Hongkonger is only 25% more productive than the average Oklahoman. And that is despite/because HK has much less land area on which to work. Key takaway: More people equals more opportunity.

(sources below)PopulationArea2019 GDP (PPP)2019 GPD per capita (PPP)
Oklahoma3.95 million69k sq miles$206 billion $52,150 
Hong Kong7.45 million1k sq miles $491 billion $64,928 
% difference89%-99%138%25%

My extreme example to illustrate the benefits of Open Borders begins with a bold proposition: I propose we open the borders of Oklahoma to ALL residents of Hong Kong to become permanent guests with the opportunity to become citizens if they so wish. 

I can already hear the dismissive laughter followed by the panicked apoplexy. "Dear God, you can't be serious!"

Of course I am! This is easy. Do you think there is something magical about the small island of Hong Kong? Well, there might be, but it is nothing a little policy changing can't fix. And fortunately Oklahoma is not too far off from the HK freedom trail. 

"But wouldn't that influx crash the local economy? Think of all those mouths to feed."

Yes, and think of all those hands to work and minds to think! 

The one big stumbling block to a massive migration like this would be finding a place to house all the people. Well, Oklahoma has 69 times as much space as HK and construction here is cheap. 

Not convinced? The heart of my extreme example is how this would affect my personal employment. When I was in HK, it was for a couple of CFA Institute conferences. While there I was treated to a personal tour of part of the city by the president of the Hong Kong CFA society. We had a chance to chat about our relative societies--I was president of CFA Society Oklahoma at the time. His society was one of the world's largest with about 6,700 members. Mine was one of the smallest with only about 170. 

So what would happen if 6,700 CFA charterholders began migrating to Oklahoma? Would there be pressure on my job? Probably not immediately as people aren't as interchangeable as classical economics assumes. Over time there would be competitive pressures, but so too would there be competitive gains. With that massive increase in talent would come much in the way of business opportunities. I would have new job offers as well as a bunch of new job competitors. Would the net effect be to lower my wages? Maybe, but even here there less to worry about. 

The median total compensation* for a charterholder in HK is about 4% higher than for a charterholder in Oklahoma. While the cost of living in HK is perhaps 67% higher than in Oklahoma, most of that is housing, which remember is much easier to come by in OK. And for those like me who own a home, this influx should greatly increase my personal wealth. 

Think about it this way: Should current charterholders in HK want more or fewer charterholders in HK? The instinctual answer is as simple as it is wrong--fewer sounds good until you answer the question of how would there be fewer. A shrinking market for any type of employment is not good for those in that line of employment. As a native charterholder I stand to gain much if other charterholders want to migrate to my community. The likely worst-case scenario isn't that I lose my job and/or take a massive pay cut. It is that my job changes and new opportunities force me to make some changes. Change is scary, but change is inevitable. I would much rather have the trends of change as tailwinds than crosswinds much less headwinds. Growth is good.

Open borders in Oklahoma for Hong Kong citizens is unfortunately not going to happen. And even if it did, 8 million people would not show up tomorrow. In fact, most would choose not to make the journey at all. But for those that did it would be a great benefit for those already in the place of their reception. 

Sources for data in table: 
*CFA charterholder compensation data is from CFA Institute's 2019 Compensation Survey, which is proprietary to members--unfortunately, I can't directly share it.