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. 

Puts: 
  • 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]...
Calls:
  • 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.

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