19 May 2004 Bram   » (Master)

Gambling on Wall Street

The Springfield daily newspaper, the Daily Star, reported that their local baseball team was slumping, and had missed the spread five games in a row (which was true). Richard Smallbrain, CEO of the Company of America, wrote a scathing op-ed piece criticizing the paper for tainting its sports coverage with gambling. Smallbrain then also mentioned that his company is a a growing part of Springfield's economy and has beat wall street expectations three quarters in a row.

How to make money off of terrorism

The traditional spy novel scenario for terrorists profiting from their work is quite dubious. Usually the scenario is that the terrorist shorts the stock of a public company before attacking it. This is a bad strategy on a number of fronts. To begin with, shorting requires that you place stock or cash in reserve, thus limiting the amount you could possibly make to a small fraction of the amount you can front. Further, the potential upside of a short is capped at the amount you get up front, thus limiting how much you can make that way even more.

Those problems can be mitigated by using puts instead of shorts, but a much more fundamental problem remains. Attacks frequently fail, and even if they do succeed they often do a lot less damage than you expected. The rebound of a stock after it shoots down can leave it higher than it started. Plus, to reliably reduce the value of a public company requires doing a whole lot of damage, and some people have moral objections to doing that.

There is a much more reliable market-neutral way to make money off of terrorist attacks. First, go long and get puts on a company's stock, with strike price at the current value and maturation times for both on the same day as far in the future as possible. Now you will be out some money and have an interesting bet going where the more the company's stock moves, in either direction, the more money you make. (A nice benefit to this approach is that options with a strike price of the current value tend to be much more liquid than the more extreme ones). If you were to hold onto these options until maturity, this would be a very risky bet, but you aren't going to do that - if you unload them in just a day or two, the bulk of change in the value of your options is going to be in the volatility level of the stock, so even if the stock price is back where it started, if the volatility has gone up you'll make a substantial profit.

Next, set off a smoke bomb in the company's main plant. If that isn't your style you can just give a few ben franklins to your friend who's about to appear on CNBC to get him to say that there are rumors that the company is about to be acquired. In a day or two everyone will probably have figured out that whatever mischief you started was no big deal, so the stock will likely go back to where it started, but in the interim volatility will have gone through the roof, so you can unload the stock with a fat profit.

If you can't be bothered setting off smoke bombs, or happen to not want to do anything illegal, there's a perfectly legal technique based on this approach which makes money due to an artifact in the way that volatility is calculated. In general volatility is calculated by averaging it over the last N days. You can search for stocks which just so happen to have had a lot more volatility over the last N/2 days than the preceding N/2 days, then long and put them, wait N/2 days, and unload your positions. Since the first half of the range will now have passed, and the volatility level in the just passed N/2 days is likely to have been between the two values, the volatility measurement will now be higher, and you can probably unload your position at a profit.

The Recursive Universe

ANKOS follows a remarkably similar format to The Recursive Universe, a much older, and much better book. The Recursive Universe is much more rigorous, uses Conway's life, and doesn't have all that pompous bullshit which ANKOS is notable for.

A funny tangent - another book by the same author, William Poundstone, gives the formula for KFC's secret spices: salt, pepper, and MSG.

The automata I mentioned in my last entry is rule 54, described on pages 696 and 697 of ANKOS. The simple-looking diagrams on page 697 are deceptive - that apparent simlicity only happens on a large scale, there's a whole lot of complicated churning which goes on before things settle down.


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