Hot wings and fast balls

Vol #227: May 22, 2025

Amateur tennis is a game for losers. It’s similar to investing in that way.

Errors, not aces, are what decide the outcome.

Professionals play for winners. Serena Williams beats you with a rocket forehand. The fourth line in the local men’s league double faults to drop the set.

Unlike with rackets, in the progression from amateur to professional in financial markets, it still remains a process of reducing mistakes. Evolving as a trader is not developing an ability to call the top or bottom for a big winner. It’s knowing that your greatest edge is refining the tools and processes you use to capture edges.

I’m a long way from playing winners tennis, so I focus on getting the ball over the net. If you don’t have someone to hit with, the next best thing is a ball machine. There are several knobs to turn here, all of them tempting. Adjust the interval between balls, the range across the court, and level of spin.

After taking a couple of easy shots, the inclination is always to turn it up. I can handle the baseline shots. Send it wider, I’ll run 'em down. Put a little bit more mustard on that ball.

Then you find yourself in a place familiar to anyone who thought they could handle more than tourist spicy. The eye watering heat that makes you instantly regret an order of Memphis hot wings.

We all have a limit, and sometimes the only way to find it is to turn it up to 11. Or Range = 5 in my case. I can’t run that fast.

“A little bit more” tempts our ego and appetite. Not one investor looks at their account and doesn't wonder what it would take to make that bigger. The answer is obvious, bring some risk to town.

There’s no hack. There’s no secret formula. The delta one theta neutral combination of calls and puts across different months with bifurcated roll programs isn’t all up, no down. More returns come from taking more risk. However that comes.

If you want twice the returns of the S&P 500, borrow an equal amount you have invested and watch your account move twice as much for every tick. The 2x seems very simple and backtests well over 15 years. The Great Financial Crisis would wipe you out though. Say nothing of the Great Depression’s -83%.

The persistent rebounding of index values steels the nerves of those seeking leveraged returns. A 40%+ drop in double leveraged strategies on April 7th has now recovered almost three quarters of that value.

The behavioral critique of leverage says that no one will be able to maintain their cool through that. But certain bitcoin holdrs have proven that there are incredibly resilient long term investors. Drawdowns are grenades on your hippocampus, but they’re also just arithmetic. It’s only a loss if you sell ;)

That argument works for me though. I’ve seen it with hot wings, fast balls, and a little bit of juice in the positions. Stop the paaaaaaaiiiiin.

It’s not just that most humans can’t handle the math, there’s also a lot more going on than just multiplication. Two times as many shares have double the capital gains (losses) and dividend payments, but did you account for interest? Cash ain’t free anymore. If you’re doing this in a levered ETF did you consider the fees or rebalancing drags?

All of these other exposures create outcomes that are more nuanced than a simple leverage ratio provides. In order to obtain results in multiples, there are necessarily several moving parts. And each of those knots creates another vector for mistakes to creep in.

With the disclaimers out of the way, there are scenarios and opportunities for when leverage is appropriate and reasonable. And when using options to achieve this, investors can also capture other dimensions of reward for assuming these additional degrees of risk.

Leveraging the outcome of the S&P 500 is a linear question. In derivatives parlance 1.2x is asking for 120 deltas per 100 deltas of underlying share notional. Futures contracts could give you only the delta with generous margin requirements. But there’s more than one way to get a delta in options.

A combo is the opposite of a collar, and with nothing underneath. Long an ATM call and short an ATM put give you something very close to a long futures position. Interest, dividends, etc all hand waived away. This will need to be restruck every period, but because the options have the same strike there’s not much other complexity. Any debit or credit is a function of the carry I ignored.

Target deltas can be achieved using out of the money options also. If you sell a 15 delta put against a long 15 delta call you have created 30 synthetic deltas. But now you don’t just have directional exposure, you’ve got a skew position with a greek profile that will shift with the underlying stock.

Fortunately those additional risks are compensated for with a premium. The typically downward sloping skew shows higher implied volatilities and prices for the put, resulting in a net credit for the long delta, short skew synthetic.

Skew exists for a very good reason - there is higher implied volatility to the downside and selling the out of the money put is also selling kurtosis and the fatter downside tail. Writers of that risk are compensated. Fairly or unfairly depending on the day.

The existence of this premium is well documented. My favorite is the Sinclair - Hull piece. They target that 15 delta call/put in a trading strategy that regularly rolls a synthetic stock component and outperforms against certain indices.

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Tomorrow in Portfolio Design, we’ll dig into the details of executing this trade. Subscribe today for access.

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Putting on this trade is its own form of leverage, even if you only keep yourself to 100 deltas per 100 deltas of capital. You are leveraged to the market because of the greek profile. (And your ability to operationally execute this.)

As stock moves and time passes, your delta position changes quite a bit. Directionally as either short or longs are tested, they will pick up value. A call going in the money will give you longer exposure as stocks are going up - great! But the same thing happens to the short put in bear markets.

Worse, that skew premium you collected comes due when vol increases to the downside. Higher vol at lower prices makes that put even more painful. And how exactly that happens changes every time, and varies where you are in your position’s expiration cycle.

Being able to manage this structure is critical. Hedging or re-striking options will prevent the exposure from overloading, but it requires time and attention.

Leverage is always spicier than you think. The one in a hundred chance will happen the first week, and your tolerances instantly tested. There will always be a vector of risk that you didn’t fully appreciate.

But hot wings are good. And I want to be able to send an ace right past the captain. If you pay attention to the details, adding a little bit of spice to the portfolio can be done right.