Leveraged Theta

A friend of mine, a guy I wish I had gotten to know better when I had the chance, a fellow engineer, Wayne Miranda, is headed to Ghana this November. He is going to help the local farming markets. He and the team from EWB (Engineers Without Borders) are going to help any way they can. He asked me for my thoughts, by basically giving me an open ended “Jeff, do you have any insight, to get me started on understanding markets and how to analyze them?”

Coincidentally, I’m actually in the middle of reading a book that was recommended to me. I say Wayne, be sure to check out “Competitive Strategy: Techniques for analyzing industries and competitors” By Michael Porter. Yes, that’s Micheal of “Porter’s 5 forces”. It even has a chapter in the book entitled “Competitive strategy in Emerging Industries”. It should at least, get you started. Like I said, I’m not done reading it…but it’s the only one I can point to that pertains to this topic. They have printed 60 editions, and in 19 languages.

The rest of this post are my philosophies. Philosophies I’ve collected through observation and with communication from greater minds than my own. Most are common knowledge, some are made up hypothesis, all are deeper than anybody first thinks. So here it goes.

Whether you’re a real-estate developer, an equities investor, an options trader, used car dealer, insurance broker, fisherman, farmer, job seeker, actor, doctor, lawyer, engineer, a bum on the street…fish in the sea, grain of rice, or any other person/organism/organization attempting to exist anywhere on earth – you’re part of a market. This is obvious to me, and likely many others, but we can all name somebody that doesn’t understand the fundamental framework behind the market they may or may not consciously be aware of operating in. For any market participant, I would say the number one word for them to be aware of for analyzing (and predicting) is IMPACT. If you want to get specific, think “Impact to yields”. That’s yields, for the stakeholders. Yields as in the benefits, the value created, from the investment of a resources (time/money/energy/knowledge/research/etc).

I hope I can avoid further rambling while attempting to explain what I mean by the aforementioned, as I discuss the complex dynamic, any market faces. It’s because of this complex dynamic, that markets are hard to predict.

At its most simplistic operations, a market, is all supply and demand. But more than just with reference to say, a certain commodity. What’s critical is the supply and demand of everything, because it IMPACTS everything else. After a while, it’s easy to conclude that everything (and everyone) is a commodity. Number of job seekers, is the supply of labor, while the employed are the supply of tax dollars. The supply of labor, IMPACTS wages. Changes in wages IMPACT the supply and demand of investment, in an industry. Wages also IMPACT tax dollars, and thus government spending, which effects consumer confidence and so on and so forth. Supply and demand of a commodity, will IMPACT the supply and demand for the end product. Which is why supply and demand are often brought to an equilibrium – by more than just the direct producer or consumer. They are brought to equilibrium, because stake holders (investors/workers/customers/etc.) chase yields (profit/money/nutrients/etc.).

Anyway…as promised, some concepts, outlined.

Causality Rules

Market participants are causal, that is they react, and often anticipate, thus can make any market appear to be anti-causal. Which in itself, creates a self-fulfilling prophecy. If people believe in likely positive outcomes, based on present actions, they will proceed with those present actions. The reciprocal is true for avoiding negative outcomes. I don’t know if this is a law or not, but it means that if an asset class, or investment in a sector, or training people for the industry, is expected to rise in value, increase yields, or provide better jobs …then, that’s what will happen. Market participants will make it so. Since the rule of causality prevails, if participants positive expectations, don’t come to fruition, or even don’t flourish with as much positive results as expected, negative repercussions will cause an outflow of investment. Eg. If people buy shares, in a company, for $X, expecting a yield of Y%, and actual yield ends up only A%, where A < Y, then shares will be sold off until the yield of the asset reaches Y%.

Opportunity costs exist

This seems obvious, but breaking this down, can get pretty over-whelming. At the heart of opportunity costs, lies the word CHOICE. Choice of impact. Any market participant has a choice to make a decision, or not. They can delay, but the delay will have IMPACT – be it delaying the good, or the bad. A choice, is an option. An option has value. The value is anticipated, based on probabilities and expectations. One can only spend dollars, time, or resources once – doing so has IMPACT. Not doing so, has IMPACT. The present value, combined with probabilities of IMPACT, is the opportunity cost.

Operating requires over-head.

Stuff will be wasted, things will go wrong, time/money/resources do have to be spent in order to maintain operations. That’s impact. Give up & give in to the fact that one-time expenses (impact) are necessary, and you’ll have more time to focus on the infinite annuities. While not to be taken lightly, the annuities should be the highest focus. Side note, this logic, is at the root of EWB’s philosophies & intentions -> the teach a man to fish vs give a man a fish complex.

Intrinsic AND extrinsic motivation persist

Employees normally work, for the money. But some break this mold, and do it for the learning. Or maybe it’s just a passion. To some it might be the love for the game, or eg, they may work as doctor because their mom died of cancer. Never under-estimate, or pretend to assume, any other player’s motivations.

Inefficiencies exist and are temporary

It’s just a question of time scale. If the yields are too good, that will change, for the worse. If yields aren’t good enough, the organizations which are weaker will fail, and the stronger will increase yields. Market forces will drive yields down to a reasonable return for the risk involved. One can argue that, a market will react to change, eventually, and that change is by definition infinite and dynamic. Thus, inefficiencies of some variety will always exist. These inefficiencies in discussion pertain to the aforementioned unfair yields. Maybe they are re-occurring, or overlapping with other inefficiencies, but in general the inefficiencies that continually persist are the repercussions of lag in foresight of market causality. Of course, the aforementioned is the direct debate to the “efficient market” hypothesis.

Irrationality persists, longer than rationality

It’s just an observation I have. It’s what leads to bubbles. Generally, human emotions (greed & fear) take over and create an arena of hardly predictable behavior. But, anticipating this hardly predictable behavior, is half the battle.

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I didn’t specifically say “IMPACT” in all of the aforementioned philosophies and ideas – but, my readers are smart – extrapolate for me.

Sigh…I rambled…oy.

I know, Wayne, your e-mail sort of requested more applied logic while at the same time recognized the vagueness of the information you sought, but, it’s late…and, i’m out of my supply of time. Let’s do dinner one night this week.