VIX options are not based on VIX but based on VIX Futures. Why ?
Read this : Link

Wow!! There is a metric to capture Variance of analyst estimates too!!

Look at this : Coefficient Variance

This could be a good indicator, the less variance, less money you can make :)

Via Vix and more : Why I thought IV was better than beta for determining volatility (past and future), here are three reasons why I think IV is superior to beta:

• Yahoo Finance, Google Finance, and other data providers sometimes list betas of 1.0 for issues they apparently have not calculated a beta for, particularly newer issues and foreign stocks
• Highly volatile stocks that go in the opposite direction of the market for awhile can sometimes have low betas – think small oil/gas exploration companies, gold miners, etc., but also consider that some tech stocks may countertrend for a long period and thus acquire a smaller beta than their volatility would suggest (historical volatility would be a better number to watch here, because it focuses entirely on the magnitude of the moves and does not care whether these moves are correlated to the broader markets)
• Implied volatility is forward looking, so it automatically adjusts to account for scheduled earnings announcements, a pending FDA drug decision, a legal issue that is due to be resolved, buyout rumors, terrorism, violence in the Middle East, a hurricane that is bearing down on the US, etc.

Some old articles / statements are worth rereading. Here is one of my favorites:

What is Edge ?

The edge is knowing that you can fail and learn from it, and just get back up and in the game.
The edge is knowing that people think your crazy, and they are right, but you don’t care what they think.
The edge is knowing how to blow off steam a couple times a week, just so you can refocus on business
The edge is knowing that you are getting to your goals and treating people right along the way because as good as you can be, you are so focused that you need regular people around you to balance you and help you.
The edge is being able to call out someone on a business issue because you know you have done your homework.
The edge is recognizing when you are wrong, and working harder to make sure it doesn’t happen again.
The edge is being able to drill down and identify issues and problems and solve them before anyone knows they are there.
The edge is knowing that while everyone else is talking about nonsense like the will to win, and how they know they can be successful, you are preparing yourself to compete so that you will be successful.

Life is a fucking joke, which i don’t get it :(

We need volatilty based trading instruments , the more the better. WHY?

Well, if one thinks of options written, all the delta hedges based on Blackscholes break down if the volatility is a stochastic process. If Vol is a function of spot and time, it is fine, but most of the cases , one cannot assume that. So, if delta hedge of Black Scholes world is useless, what can one do ? Look for volatility based trading instruments like VIX and then delta hedge it.

I guess it is not all that bad a tool, for a 3 day effort . I had to get this up and running - rails-postgres-gruff , for that is the only way I can think of analyzing why long shorts on a massive portfolio are not converging. Now that I have got a microscope in hand, hopfully it will be fun to look at individual stock level Mean reversion processes and learn what the hell happened in Jan - Mar 08.

My philosophy of PR is summed up in six words: be amazing, be everywhere, be real.

- Jason Calcanis ( Mahalo Founder)

If one looks around, there are a tons of innovations happening in the financial sector.

• From the instruments side, the world has graduated from simple plain vanilla options to exotic derivatives, CDO’s on CDO , an alphabet soup of all mortgage derivative products. Ideally all these should help in better management in risk, right ?
• There are more players in the markets, different types of players, hedgers, arbitrageurs, speculators, market makers, hedge fund managers, prop desk traders etc. These players should be smart enough in making the market more stable ???
• Tons of legality around stock markets and asset trading, new rules to shorting etc,
• Infrastructure to support trading has grown by leaps and bounds. On your vacation to hawai, lying on a beach, you can execute a complex derivatives trade with a click ,
• Price transparency wise , again a big yes
• More crisis, More boom bust cycles.

All the above should have made the investors more wise and made the markets efficient, less volatile. However we are seeing the markets becoming more volatile, more manias , more structurally inefficient products being traded,..Does it sound like an irony ? Well, this book sets out to explain WHY ? The author has been a trader in MorganStanley , Smith Barney, LTCM, and has worked on a host of significant roles that his view can be understood not from a passive spectator narration of somebody but from a perspective of a player in the market. This means that it will be more - matter of fact - rather than color it from journalist flavor.

This is the second post on this book which will try to summarize the chapters on Hedge funds from this book.

Brave new world of Hedge Funds

Hedge funds exploded in to the financial world in the recent years. There are various types of hedge funds, classic one being top down. A few nice take aways from this chapter is the discussion of tulip mania where the author reasons that the existence and flourishing of futures market was the reason for speculative mania. Also a discussion of the importance of float in the market is discussed in the context of Internet bubble.
The biggest takeaway from this chapter is the answer to the following : Why does the price move ? It moves because of liquidity. Unlike the MBA crap that information moves price, this explanation is nifty . Broker dealers provide liquidity to the clients and they trade in suck liquidity. Elegant view to look at intra day price movements.
The author talks about the rise of pairs trading technique, relative value trades, LTCM and the recent evolution of long/short portfolios . I never knew that Bamberger from Morgan Stanley was the actual brain child between Pairs trading and Tartaglia stole it and scaled it .

I was rereading Paul Graham’s article and these words made a lot of sense AGAIN.

One of the best tricks I learned during our startup was a rule for deciding who to hire. Could you describe the person as an animal? It might be hard to translate that into another language, but I think everyone in the US knows what it means. It means someone who takes their work a little too seriously; someone who does what they do so well that they pass right through professional and cross over into obsessive.

If you ever want to analyze data using charts , and , excel -data interaction becomes overwhelming, then one needs to write one’s own charting infra..I was in a similar position where excel based charts were not enough for my analysis. There was simply too much data to look at and hence ended up writing my own diagnostic tool using rails-postgres . Gruff a charting library for rails proved to be INVALUABLE.

Q) What were the recent changes to the Dow Composition ?

Deletions : Kodak, International Paper, and AT&T
Addition : Pfizer, AIG, and Verizon.

Bloomberg.com:

About 33,300 finance jobs in New York City, or 7.1 percent of the 2007 peak, will be cut by June 2009, the Independent Budget Office, a non-partisan monitor of city finances, estimated in a May report.

Heard of CDBaby.com . If you are music fan, you would have ..Here are a few stats which make the site real cool : ($84 M of real value to the artists..wow!!)

# 244,574 artists sell their music at CD Baby
# 4,606,776 CDs sold online to customers
# $84,085,098 paid directly to the artists

Something interesting on their site -:)

# Our servers are running Linux, Apache, PHP, and MySQL.
# No Microsoft products were used in the creating of this website.

Theta: Do American Options have positive theta /time decay ? If Yes , Why ? If No, Why not ?

Related question:
Give an example of a situation where you have postive time decay in european case ?

I have a problem with Ruby. It is a great language , extremely good for fast prototyping. However this is not the language I use it daily. However, there are times when I have to use ruby where the effort of doing something in a different language is not worth it.

My problem stems from the fact that I forget the syntax as I don’t use it regularly. In the last 1 year , I would have probably worked on 4 RoR mini-projects and in every instance I had to pain stakingly go through and review the syntax . This time again I have to develop a diagnostic tool, very very fast and I don’t have time to go through the syntax at leisure. I did something different. Picked up this book “Making use of Ruby” and put myself a time limit of 30 minutes for reviewing the relevant syntax..All I can say, is that, the result is pretty good…In 1/2 hr time, one can review the syntax of loops, classes, namespaces, mixins, file operations , instantiations, arrays, hash etc and I must say this book is pretty well organized in that sense. First 120 pages is that would be needed for quick prototyping.

The trading strategy that I have been trying to back test does very badly in one fortnight. Huge drawdown!

Have been trying to figure out an answer to the question ? why? Hoping to find an answer soon.

It is a beautiful day outside, a little drizzle which I can see from my window, a silence which allows a mind to clearly think and reflect. I don’t have to go to work today.I don’t have to think of bug fixing, deadlines, work allocation, assignments, grading, etc for ONE day. What can I think of doing in the coming 24 hours ? Sometimes the feeling of having 24 hours to yourself is quite liberating.

Another difference which one can keep in mind to understand the philosophical difference between Bayes and Fischer’s way.

In the context of parameter estimation,

Bayes World : Parameter is random and credible intervals are fixed and one talks about the probability that estimator is present in that interval.Probability being referred to the posterior probability of the parameter

Fischer’s world : Parameter is constant and confidence intervals are not fixed. For example 90% confidence interval means, if a large number of independent 90% confidence intervals are constructed, then approximately 90% of them will have the true parameter.

If a trading strategy makes money continously for the last 6 years with 40% annualized return, what should I make out of it ? Is it really that GEM of a strategy OR is it a BUG in my code and I am living in a fantasy world. Have been struggling for the past 4 days. Hope to answer the question soon. I don’t wish anything as of now..Just want to see some correct numbers, even if the numbers turn out to fantastic or pathetic :)

By Endurance, we Conquer - Ernest Shackleton

Via FT:

The New York Stock Exchange is responding to the sharp rise in algorithmic trading by introducing technology designed to give NYSE floor brokers the ability to trade algorithmically and more easily locate large sources of liquidity.

Algorithmic trading uses mathematical models as a means of trading large blocks of shares quickly. Tabb Group, the US consultancy, predicts that by 2010 algorithmic trading will account for half of all US equity trading. Floor brokers will also be able to search for deep liquidity by broadcasting and subscribing to specific stocks in which they have a large interest.

Via Raghu :

“He that hath wife and children hath given hostages to fortune; for they are impediments to great enterprises, either of virtue or mischief.”

Francis Bacon (1561-1626).

For some reasons, I just couldn’t take out time for blogging..Hope to restore my default settings :)

“Ease yourself into the language. Don’t feel you have to use all of the features, and don’t try to use them all on the first day.”
- Bjarne Stroustrup on C++

The clouded mind sees nothing

Mitchell Baker on his experience at Firefox(record for the highest no of downloads in 24 hrs - 8 Million):

“Every once in a while — for those people who are really lucky — we get to experience a moment where everything comes together. A period where dreams and hard work merge together with remarkable results.

This is such a time for Mozilla.

It’s based on hard work and execution of course. The number of people who have done something unexpected in the last few months, something that changes the outcome, is very high. But that’s only part of it. And there are plenty of times in life — most of life for most people, in fact — where people work hard and pour themselves into their effort but don’t experience the lift and buoyancy of sense of validation.

The stock (PETROLEO BRASILEIRO) and its relevant ETF(MSCI BRAZIL) is a great example of mean reverting stock with respect to its ETF. Here is the yahoo chart : Mean Reversion

If one looks carefully, one can definitely find a lot of stocks where the residuals mean reverts…But the challenge is to do it on a large number of stocks quickly…Why should one do that ? Even you get beaten on one mean reversion trend , you are always safe, thanks to Law of large numbers.

Understanding a theory means Understanding it as an attempt to solve a certain problem

-- Sir Karl Pooper

Simple ideas are usually very powerful. “Pairs trading” is based on one such simple but powerful idea which generated millions in profits for various firms. Morgan Stanley which first implemented this strategy and a host of other firms which copied this technique and made a lot of money.

Pairs trading is based on 2 constructs :

First, Any stock moves in a random way , however there is a systematic component to it and idiosyncratic component. In simple terms  , there is a component you can identify with a set of factors , and there is another component which is stock specific. So, you can pick a pair of stocks such that the systematic component of one stock is related to the systematic component of another stock.. Thus you have a grip on the spread.

“Smile, breathe and go slowly.”
-Zen

Consistency is the last refuge of the unimaginative. - Oscar Wilde

The intellectual effort in writing a medium sized program is probably comparable to writing a book, except you never need to debug a book! There is a joy to finding out new ways to make something happen, or solving a particularly thorny problem. - David Bolton

The Fringe Benefits of Failure, and the Importance of Imagination

President Faust, members of the Harvard Corporation and the Board of Overseers, members of the faculty, proud parents, and, above all, graduates.

The first thing I would like to say is ’thank you.’ Not only has Harvard given me an extraordinary honour, but the weeks of fear and nausea I’ve experienced at the thought of giving this commencement address have made me lose weight. A win-win situation! Now all I have to do is take deep breaths, squint at the red banners and fool myself into believing I am at the world’s best-educated Harry Potter convention.

The highlight of the book is the following statement :

Any model should consider the following :

1. Transaction Costs,
2. Risk,
3. Return,
4. Market Efficiency

and the objective of a investment strategy should be minimize first two, maximize third and work around the fourth. Liquidity and Taxes are the additional elements to make any model realistic.

Coming back to what the book is all about,

It is about Alpha, a term used to represent , excess of benchmark returns generated by a fund manager. This book talks about the eternal quest for alpha and poses a lot of interesting questions. It begins with a history of passive indexing strategy and then tries to bring out various perspectives for seeking alpha. Ross’s APT, Markowtiz Portfolio theory, Sharpe’s contribution, Tobin’s Separation theorem are some of the historical aspects which the author brings out in a conversational mode. The rise of managed futures , behavioral finance, quant jocks , var and the hype around it, etc are highlighted in the book.

The highlight of the book is the following statement :

Any model should consider the following :

1. Transaction Costs,
2. Risk,
3. Return,
4. Market Efficiency

and the objective of a investment strategy should be minimize first two, maximize third and work around the fourth. Liquidity and Taxes are the additional elements to make any model realistic.

Coming back to what the book is all about,

It is about Alpha, a term used to represent , excess of benchmark returns generated by a fund manager. This book talks about the eternal quest for alpha and poses a lot of interesting questions. It begins with a history of passive indexing strategy and then tries to bring out various perspectives for seeking alpha. Ross’s APT, Markowtiz Portfolio theory, Sharpe’s contribution, Tobin’s Separation theorem are some of the historical aspects which the author brings out in a conversational mode. The rise of managed futures , behavioral finance, quant jocks , var and the hype around it, etc are highlighted in the book.

Couple of folks have emailed me to post the link of the article that I was mentioning in one of my previous post. The document attached with this post is perhaps a remarkable view from a person who understands both sides of the world, Fischerian and Bayesian, and proposes an alternative view for design inference.

One can’t speed read this document. The article needs to be read slowly to understand it thoroughly…It is certain to make any reader wonder about the effective use of stats for drawing inference

Via Derivatives Strategy - Dec'97:

What do you think of value-at-risk?

NT: VAR has made us replace about 2,500 years of market experience with a co-variance matrix that is still in its infancy. We made a tabula rasa of years of market lore that was picked up from trader to trader and crammed everything into a co-variance matrix. Why? So a management consultant or an unemployed electrical engineer can understand financial market risks.

Recently, I stumbled on to an article which had a debate between Fischerian approach Vs Bayesian approach for design inference. According to the author, both had drawbacks when dealing with events with small probabilities. I became curious to know the bayesian side of things. My work in the past few years did make me use Fischerian approach in many forms..But What about Bayesian world ? Except the famous MontyHall problem and few other general examples, I had not read or understood clearly , how a bayesian approach could be put to real use. Many years ago, reading, “Hackers and Painters” , I did come across an entire chapter of applying bayesian principles to fight spam, written elegantly by Paul Graham. However at that point of time, my motivation levels for bayesian approach were low..May be I never understood anything at all, except have a 10,000 ft view of the entire branch of statistics.

Here is a firm which is using Reverse Law of Large Numbers (RLLN) for trading.

Link : Investments

Mr Kelly’s work is all about what happens when the size of the sample is decreasing instead of increasing. He has recently turned his attention to the credit crunch, and in particular to how the RLLN affects the “balance of expectations” in financial markets.

via :emii.com

Globally, Hedge funds posted an estimated outflow of $5.9 billion in April after posting an estimated inflow of $22 billion in March.

AVOID THIS BOOK

This book has a deceptive title " Analysis of Financial Data".Sadly, it does not help an analyst in anyway.. I went through the book and it did not add an iota of knowledge about analysis..It is 10,000 ft view of stats and its usage in finance.Even the 10,000 ft view is hazy!!!.. It gives a set of formulas with no explanation whatsoever. This book is nothing but huge number of english words filled between statistics jargon.

I have always felt that an Indian version of payscale.com would work.It has to. There is so much of discussion on “who makes what”, that I will completely surprised if customized concept would not work.. Here’s another new company in the same space.Glassdoor.com

It is just a matter of time when some Indian entrepreneur will pick it up and go for a concept arbitrage

via blog.pmarca.com:

Curiosity is a proxy for, do you love what you do?

Anyone who loves what they do is inherently intensely curious about their field, their profession, their craft.They read about it, study it, talk to other people about it… immerse themselves in it, continuously.

And work like hell to stay current in it.

Not because they have to.

But because they love to.

Anyone who isn’t curious doesn’t love what they do.

Iron rusts from disuse;
Water loses its purity from stagnation, and in cold weather becomes frozen;
even so does inaction sap the vigors of the mind.

- Leonardo Da Vinci

“Against the gods” is a beautiful narrative on the history of risk management. Peter L Bernstein , the author of the book has a done a terrific work of narrating the evolution of risk measurement. The book is divided in to 5 periods where the story of risk is presented.

The five demarcated periods are Uptil 1200 ,1200-1700,1700-1900,1900-1960,Post 1960.

In each of these periods, the author talks about various personalities involved. Let me recap the book in the same manner, listing the main items from each of these time periods.