Need a flamethrower? I can get you one for sixty bucks.
Grab a can of propane and head over to Home Depot. It’s simpler than a potato gun, just as fun, and far more practical.
Usually advertised as a weed torch, it can also be used for roofing, even melting snow for the particularly impatient. I needed a flamer for my shou sugi ban.
Evolving from the 17th century Japanese technique known as yakisugi, it preserves the wood by charring the exterior with several rounds of torching. “Sugi” refers to the Japanese cypress, but fortunately it also works on pines, cedar, and oak trees.1
After a healthy wire brush down, the burnt shell will protect the lumber against moisture and pest invasions. Not only is it totally chemical free, it looks pretty cool. Plus who’s going to turn down the opportunity to play with 500,000 BTU from the Flame King?
The material had been harvested (wink wink) from trees that had fallen in the woods around my property. With many stiff branches, pines held their trunks off the ground, leaving them quite well preserved. A quick afternoon with the chainsaw (also fun to play with) and these were starting to look a lot like lumber.
A 2x4 from a big box store is rarely perfectly true. Natural lumber was surprisingly straight - trees are better at growing upwards than handlers can stack wood. Yet it came with an unsuspecting rub - all those supporting branches were joined to the trunk at a knot.
When you accidentally hit a knot with a drill, forward progress stops and smoke starts coming out. It took an angle grinder and elbow grease to smooth these into hand rails and fence posts. And they were particularly stubborn against the torch.
Stripped of the bark, raw wood only takes a few seconds of inferno level heat to char. Knots took multiples longer, staying pine white despite being blasted with blue flame. The joints were the most resilient part of the tree.
That’s rarely the case. Whether you’re running conduit or tacking a frame together, the connection points are usually the weakest links. Too many 90 degree angles and the electric signal fades. Simpson names their fasteners Strong Ties for a reason.
When nature’s components are bolted together, it’s an artificial construction. We wouldn’t have balloon frame houses without that, but the weak points are obvious. Complexities arise from conjunctions; in grammar, with colleagues, and most importantly your portfolio.
Harry Markowitz is a Nobel tier economist who asserts that diversification is the only free lunch in investing. Uncorrelated assets create a balanced return stream that compounds more effectively than individual positions - even high performers. It’s the logic that drives ETF construction and portfolio theory about the efficient frontier; mixing stocks, bonds, and perhaps alternative assets.
Yet every additional security in the mix introduces a new vector of complication. Interest rates will have an impact on how equities are priced, but with fixed income and real estate also affected, you quickly need a covariance matrix.
Uncorrelated performance is no guarantee, and the unchartered future is likely to contain a scenario that stresses your position in unforeseen ways. Further complications arise as allocations must be rebalanced and traded.
While the knot of a limb joining the trunk is particularly strong at the core, it opens up a weak point for the tree. As branches fork off, the bark never quite grows perfectly around. An “I” is easier to wrap than a “Y”. Pests and molds, all love to creep in at the seams here. These are the transaction costs and rebalance timing risks from moving your money into different buckets.
A kindergartner’s drawing of a tree shows us why this diversification is important. There are no trees that look like the one on the left, and while my MS Paint skillz aren’t what they used to be, a forest contains species that look a lot more similar to the right hand drawing.
Where each of these branches joins against the trunk is a risk factor, yet it’s necessary for the tree to grow and thrive. There’s a broader canopy, and more opportunities to photosynthesize. Not to mention the broader ecosystem benefits of additional habitats or shade.
Options add even more joints and weak points. With all the expiration timings and bid ask spread costs, that nice neat overlay could actually be letting in some moisture. A few cuts with the risk scalpel, and your exposure to the underlying looks very different.
With a pure options strategy, diversification might not always be what it seems. As a market maker you got paid to price and inventory risk. Portfolio management was measuring and hedging your sensitivities, simply with stock and delta2, and using like options to mitigate gamma and vega risk.
Last week’s Portfolio Design segment covered how to replicate this with VX futures, and demonstrated a mid-teens CAGR - with roller coaster volatility.
One reader suggested a hedge to this strategy where you could remain short volatility and but get long gamma as a protection. That sounds logical because the days when futures move the most (February 2018 with Volmageddon, March 2020 with COVID, August 2024 with interest rate temper tantrums) the market is probably getting choppy.
If you want the full dive into this hedging strategy, subscribe to get tomorrow’s edition.
The short answer is that hedging short vol is harder than it seems. There are some sizing questions to tackle, but a naive long straddle position as a hedge only has PnL correlation of about -27%. A diversifier sure, but it’s not a panacea to offsetting risk. High vol means high straddle prices, which tend to be fairly well priced day to day.
When building a portfolio of different asset classes, and particularly when introducing options strategies, it’s important to understand just what kind of joint you’re adding. Is this allocation going to be a man made junction, where the weakest points are where two parts meet?
Or does your investment follow nature's example, with forged strength and resilience at the intersection? While there still is risk in any complexity, seek opportunities that provide a broader canopy, and are robust to the changing seasons of the market.
Traditionalists will quibble about the broadening of the term here. The authentic technique uses a fire rather than a torch, and is only done with Japanese cypress. It’s also uniquely reserved for thinner siding applications. Sadly my fence won’t qualify as true yakisugi, but I still think it looks pretty cool.
Even delta hedging with stock has complexities if the dividend rate changes, stock goes hard to borrow, or some other corporate action breaks the expected link between these two.