Embracing YOLO

Vol #202: November 7th, 2024

You can get fired for making money. 

It’s not the preferred outcome for anyone - positive PnL drives profits and pay checks. Turning risk into revenue is a far from simple endeavor, and everyone needs traders who can do that. 

Up on the year and getting called off the floor to sit down with HR, means something is off. Not worth the liability. You’re making money the wrong way. Either breaking the rules or taking too much risk. 

If you want to push the limits like Martin Shkreli - it’s going to be the Justice department that says so. Maybe you paid your investors back and then some, but there’s still a bit of fraud to deal with. But even if it's only FINRA knocking at your door, violating regulations to generate revenue is as close to objectively wrong as you can get.

Businesses might do cost benefit analysis at the fuzzy edge of compliance, but systematically trafficking on the wrong side of the line is going to catch up. Access to the markets is primo. If you cut that off with too many marks on your Form BD, the game is up. Even if the fines are accounted for in your expected value, you can’t trade from the penalty box or a lifetime ban. 

The least formal rules would be the protocols of a trading firm. It’s still the law of the land, so don’t do something stupid like trade a stock you’re not permissioned for, card up a dividend play “accidentally”, or ask the clerks to hold off putting in a trade until you get the hedge. 

With the legalese out of the way, the more commonly wrong way to make money is by putting too much capital at risk. Blowing up a stack puts you out of a job if it’s someone else's dough, and into a job if it's yours.  Don’t jeopardize the balance sheet. Unnecessarily.*

The asterisk there is because my size is not your size, and we all have a slightly different interpretation. There are reasonable disagreements about the value of necessary. 

Risk is fundamentally a question of size. You cut your risk in half by reducing your positions by the same amount. Your conviction may be unbounded, the margin account is not. The most famous system for determining bet sizing is the Kelly Criterion, with inputs being your bank roll, the edge you see, and the price you’re getting. 

Two of those are objective values. It’s like arguing over the underlying price when valuing an option. The edge you see is a function of your valuation, models, and calculations. If your value is the market value, there’s no reason to bet. 

To the extent that you do see an edge or would accept a risk transfer at the given level, the valuation is driven by probability. Odds are conceptualized as “60 in 100” because there’s an element of uncertainty. 

That uncertainty can only be resolved by outcomes. This creates tension in the idea of making money the wrong way. Ex post, so long as you are not violating rules, is there a wrong way to make money? You were right. That value WAS under or overpriced. With a bird in hand, your critics must update their priors. 

Turning down a positive track record is a judgment about the process. It’s suggesting that something is broken in how the trader values or sizes their bets.  The samples we see are not reflective of what a future expectation holds.  Your risk system is eating junk food and that will come due. 

Overly risky bets, where a too large percentage of the capital is on the line, are derided by “serious” investors. Yet they are becoming ever more popular and feted by communities of retail traders. The YOLO trader wins something whether he’s a victor or a martyr. 

Since that’s not a process driven trade, it can’t be taken seriously. But what if it doesn’t need to be a process, and what if the judgment on valuation isn’t naive?

What keeps every fat pitch swinging punter coming back, is that it just needs to work THIS time. Forget being a .300 hitter, I just want the bottom of the ninth, bases loaded glory. 

There’s a certain fatalism to that kind of one-off logic. We know from the Prisoner’s Dilemma that one off games produce sub-optimal outcomes from self-interested participants. The results of a process are more robust and predictable. Highly desirable features. Yet so is winning. 

Election betting contracts were all the rage this cycle, and there was much focus on the Polymarket whale, eventually identified as a French retail trader. “Theo” had bet approximately $30M on a Trump victory, which he claimed was a significant part of his liquid net worth. 

This seemed so crazy that it was widely speculated to be some kind of underhanded trick to sway voter sentiment. The polls had long held the odds within a tight margin of 50:50, yet on prediction sites Trump reached over 60%. That kind of “edge” says get long Harris, yet here is our lone wolf nearly $50M richer. All on a well researched hunch that neighbor polls were more informed. 

Smearing a YOLO success is easy. You got lucky. Most times that doesn’t work. But perhaps traders are paying up for YOLO opportunities, because the vibes are saying they’re cheap. And some do hit. 

The consensus value of the St. Petersburg paradox is rising. I’m willing to pay up for a chance at all the money in the world. Or at least what feels like it.

The classical game of ducats is such that you toss a coin until it lands heads. At each flip the pot doubles. 2, 4, 8, 16, etc. A quick expected value calculation shows that as your probabilities drop, the payoffs grow in tandem. An infinite sum. But no reasonable person would pay even fifty bucks for the game. Hence the paradox.

Logically this is resolved several ways. The original solution was that there is declining marginal utility to infinite amounts of money. There’s also a flavor of prospect theory where risk aversion drops the value. Finally, there's the simple question of whether the banker can pay. Even if you could bet against Elon Musk’s near $300 billion of wealth, the game should only be worth about $39. 

Infinity is a long way away. But I’d pay up quite a bit for a fraction of that expected value.

The limitations on the paradox are fuzzy, where the math is cold and hard. That allows the vibes to shift what reasonable people would pay or do. A quick scroll shows that a lot of people are still finding utility for their billions. And besides simple life changing money has a much more realistic chance of happening, so that’s worth a shot. 

I’m a financial advisor, so I certainly am not telling you to go out and YOLO trade. Any serious endeavor has to be well risk managed. But they don’t deserve as much derision as they get. After all, this time they were right.