In the heat of summer, on the day of the solstice, I pine for winter days.
The bosomy slopes all covered in white, begging to be carved up and slid down. While the pool is nice, it’s hard to find a simpler joy than a sleigh ride.
Grab a toboggan, an inner tube, or just a tray from the dining hall; there’s a broad range of equipment that works. The sledder needs something to ride down the hill upon, but most anything that’s flat and smooth gets the job done.
The most fun cargo for a sled is of course yourself, but they can also be particularly useful tools for transporting something heavy. When I needed to move a pile of dead tree trunks across the yard, the solution was to tie a rope to a mixing tub and drag them downhill.
As the cargo gets more sensitive, the sled gets more advanced. Moving large pieces of bluestone recently, a few wooden dowels become rollers to slide it into position, and wheels get added to form a simple cart. I was paying attention in history class, and it paid off in ways I never imagined. Rock like an Egyptian.
Woodworkers know of another kind of sled, used to handle cross cuts and routing tables. Once you’ve hit the power switch on a table saw, you know why those fingers need to stay very far away.
You can buy these off the shelf with angles and alignments for precise cabinetry jobs, but when the cut is unique it might require you to build your own. The OG carpenter will have as many sleds and jigs as jobs he’s done.
More time is spent on building the tool and the supporting framework than making the cut that everyone sees. Beyond just measuring twice and cutting once, when power tools like routers and table saws come into play, the vast majority of time is spent in prep.
While the resulting picture frame or bottle shelf is what hangs for all the world to see, the real project is the tool. Sweat, tears, and hopefully only incidental blood went into the gnarly looking set of clamps and supports that perfectly sets trim against the blade. Hours of fine tuning and practice cuts before a ten second pass creates a perfectly smooth quarter round.
The same principle applies when you’ve dropped your toolbelt and fired up Trader Workstation. At least power tools have SawStop features to save your finger - there’s nothing like that with 0DTEs, which are likely to cause just as much harm.
For the vast majority of investment strategies, the kit is as simple as a hammer and nails. You probably need more expertise to hang a picture frame than to buy an index fund. Once you wade into options, I’ve said before that the straddle should be your hammer. If you only have one datapoint, look at the prices of the at the money call and put.
While there is no piece of information that’s more valuable, the straddle alone is not quite the foundation for a proper strategy. If you’re going to be actively trading options, you need a comprehensive tool kit. And that isn’t available at Home Depot, Lowes, or your specialty hardware store.
The tools that we use and build must be customized for the types of edge that we’re hunting. And more importantly, the process of creating that tool will deliver even more value than jumping straight into the results.
Options traders are concerned with the price of volatility. At face value it’s a simple calculation of standard deviation, but the choices of data and methods can produce significantly different results.
Andrew Mack nailed this sentiment perfectly earlier this week:
To price the future path of volatility - i.e. the value of an option - most practitioners take some view of the past, and mold it into the present context. The sun always rises in the east, but every day is a new opportunity.
The past can be measured in several different ways. We can look at the range of prices over the prior 30 or 90 days. We can look at the 30 day historical volatility measured over the past year. That’s good information to help contextualize what kind of PnL path to expect from holding a stock.
As strategies focus on shorter term trading opportunities, we must adjust the volatility metric. Using something like Parkinson’s method to isolate movement during the day will frame the prices of options expiring in a few hours.
A range of different calculations are available for free from your broker, and hundreds more with a simple data subscription. But if you just pull up someone else’s metric, you’re missing out. Without opening up the hood on the calculation, or better yet doing it yourself, there’s a lot of alpha left on the table.
Knowing that the current level of 20% implied volatility is lower than the 30% historical average is something ChatGPT could trade on. The LLM might even be able to figure out that there was a holiday in the calendar yesterday, but the best intuition for how to trade around a mid-week market closure comes from scrubbing the data and getting your hands dirty.
Last week Ari Pine wrote a flattering review of the work that Kris Abdelmessih and I did on TSLA covered calls. He nailed something that I understood intuitively, but had never put words to. The purpose of our exercise was not to find some secret formula for success, but the effort was worthwhile because “you need to build a body of work to create your own mental database.”
The tool is powerful because it helps you understand how markets work, and the best way to do that is to get a lot of reps and construct your intuition.
I spend a lot of time designing backtests for both myself and clients. All of the p-hacking and ‘past performance is not future results’ parts aside, they’re the single best way to frame a strategy. And while the Sharpe ratios and gross PnL that is theoretically produced are good sorting mechanisms for what does and doesn’t work, the lessons learned from building the tool are even more important.
When you’re forced to handle the inevitable data questions about finding the right strike, or investigate the big negative PnL from a wide market, you learn something about microstructure and market dynamics. The Flash Crash and Volmageddon both spiked spread widths wide - a reality that will necessitate different cash management than simple close of day marks might indicate.
If you push a backtest out past the most recent few years, there are interesting and significant evolutions in how options are traded. While I celebrate the number of strategies that are now possible with all the strikes and expirations listed, it’s hard to get a view of how they perform outside the recent paradigm.
It also makes you question how market structure will impact both trade pricing and opportunities in the future. The texture of how this has evolved isn’t captured in the summary statistics. To be prepared for the future - let alone prognosticate about it - there is no substitute for getting your hands dirty in the past.
Working with a backtest, most of the time is spent evaluating and analyzing the how and why. The lessons that I take for myself and share with others are not to set your delta to .30 and DTE to 14; they’re about color, texture, and underlying dynamics that drive returns.
While I learned quite a bit piecing together the custom sled that’s built to perfectly route the wood trim I need in the barn, every project comes to an end. (Despite what my family and friends think.) There is a final nail, and the results are what you get to show off.
Trading the markets is more like an ecosystem where there’s always a new and slightly different project. To be prepared for the next cut, it takes a deep understanding of the tools that you have, and a fastidiousness to the lessons learned forging them. While the scrolled edges are beautiful, you also shouldn’t underestimate the power of a simple wooden dowel.