Financial Essays: Price and Returns and Cost of Leverage

Cost of Leverage - Published by Joel Stevens on October 11, 2016

This essay relates to the "Cost of Leverage" of various different leveraged vehicles for investing in common shares, such as using margin or purchasing calls or warrants. Additionally, the essay explores the relationship of Cost of Leverage as the degree to which the call or put is in or out of the money.

Price and Returns - Published by Joel Stevens on December 31, 2016

This essay relates to the relationship between price and returns. In particular, the essay explores how returns develop over different holding periods, underlying value growth, and prices paid relative to that underlying value.

Book Review: Good for the Money

Good for the Money: My Fight to Pay Back America - Bob Benmosche

As an investor in AIG since 2011, I was very interested in this book, which provides the inside scoop (at least from Benmosche's perspective) of the recovery and payback of the bailout money in AIG.  I was impressed with Benmosche during his tenure as CEO as an investor, and after reading this book, I am even more.

Benmosche goes through his career, in a fairly abbreviated form, as a guy that is rough around the edges, but gets shit done.  That characterization seems a perfect synopsis for the AIG recovery, where the government and the press might not be too happy with him, but he got everyone paid back his way.  Although I'm sure it was difficult to see at the time, it does appear that his much slower approach to realize the value of assets as AIG was much better than the originally planned method of selling everything as fast as possible, which likely would not have yielded enough money to pay back the loan from the government.

As I was originally, I was again saddened by his cancer and eventual death.  Benmosche's effort at AIG throughout that period was impressive.

Another Slew of Book Reviews

Still falling behind on both reading and writing book reviews.  Hoping to have more time soon.

The Spider's War - Daniel Abraham
This is the final conclusion to the Dagger and the Coin series, which was overall pretty enjoyable.  Pretty good story with fantasy and financial engineering, so how can I complain really?

Gene Wolfe has been recommended to me several times over the years, so I thought I would give this series a shot.  It was very interesting, but a pretty frustrating experience.  Supposedly, it is Science Fiction, but it is written like Fantasy (the reader is left to use his imagination as to how the magical descriptions can be explained by science).  It also uses an unreliable narrator story telling mechanism, and many details are left out all of the time.  Often, I had to figure out whether I missed something or if the story teller had purposefully left me in the dark.  Usually it was the latter.  I didn't enjoy having to work so hard to just try to understand what was happening.

Calamity - Brandon Sanderson
Fun ending to a fun series (The Reckoners)

Both of these were quite good, but of the two, I'd definitely recommend It's Easier than You Think.  

Yet another Epstein book whose premise and beginning is amazing, but who's content is very frustrating.  The beginning and the title are such a good concept for a book, but somehow Epstein spends 33% or 50% of the book talking about how the Buddha was traumatized from his lost mother and pre-memory traumas, rather than focusing on the trauma of "everyday life".  As usual, I wish he had condensed down to a chapter or two.  I don't think I'll bother reading any more of his books, as it is almost always the same situation.

When Breath Becomes Air - Paul Kalanithi
This book is essentially an autobiography of a neurosurgeon who pushes himself incredibly hard throughout his medical training, gets cancer, and dies before he can finally "get" the life he was working towards.  While there are many touching segments, and of course, many sad moments, and while he does have some good thoughts about the interplay of doctors and patients, I can't say I got much out of it.  While dying may teach you quite a bit in a short span, I feel that there is more to learn from the wisdom of a 90 year old than a 36 year old who spent his whole life pushing himself through medical training.

Rational Enlightenment Essay: You Are Not Your Feelings

You Are Not Your Feelings

or Growing Up, Phase II

Now, one who says, 'Feeling is my self,' should be addressed as follows: 'There are these three feelings, my friend — feelings of pleasure, feelings of pain, and feelings of neither pleasure nor pain. Which of these three feelings do you assume to be the self?' At a moment when a feeling of pleasure is sensed, no feeling of pain or of neither pleasure nor pain is sensed. Only a feeling of pleasure is sensed at that moment. At a moment when a feeling of pain is sensed, no feeling of pleasure or of neither pleasure nor pain is sensed. Only a feeling of pain is sensed at that moment. At a moment when a feeling of neither pleasure nor pain is sensed, no feeling of pleasure or of pain is sensed. Only a feeling of neither pleasure nor pain is sensed at that moment.  Now, a feeling of pleasure is inconstant, fabricated, dependent on conditions, subject to passing away, dissolution, fading, and cessation. A feeling of pain is inconstant, fabricated, dependent on conditions, subject to passing away, dissolution, fading, and cessation. A feeling of neither pleasure nor pain is inconstant, fabricated, dependent on conditions, subject to passing away, dissolution, fading, and cessation. Having sensed a feeling of pleasure as 'my self,' then with the cessation of one's very own feeling of pleasure, 'my self' has perished. Having sensed a feeling of pain as 'my self,' then with the cessation of one's very own feeling of pain, 'my self' has perished. Having sensed a feeling of neither pleasure nor pain as 'my self,' then with the cessation of one's very own feeling of neither pleasure nor pain, 'my self' has perished. 
Thus he assumes, assuming in the immediate present a self inconstant, entangled in pleasure and pain, subject to arising and passing away, he who says, 'Feeling is my self.' Thus in this manner, Ananda, one does not see fit to assume feeling to be the self.

Like many children, I loved water and swimming.  When I was young, a friend of ours had a pool, so naturally I begged to go as often as possible.  On one of those happy summer days that my mom took me, after some endlessly entertaining underwater acrobatics, I came up for air.  Unfortunately for me, there happened to be a bee inhabiting that particular spot on the surface of the water, and I was promptly rewarded with a sting to my eyelid.  As you might imagine for any young child, my reaction was loud and traumatic—I was pretty sure my world was going to end, and for several minutes, it really felt like it had.

Later, as an adult, I was playing as a bassist in a jazz trio.  The venue had an outdoor patio looking over the hills of Austin, which was particularly nice at sunset.  After finishing “All Blues”, I reached down to take a sip of my beer (compliments of the house).  In another unfortunate happenstance, a bee had decided to take his own drink!  Mid-swallow, I was alarmed to feel movement in my mouth and, very quickly, a burst of pain.  After successfully removing the bee from my mouth, I soon realized that my discomfort was not yet over.  A bit of oral exploration later, I discovered that the stinger was still firmly lodged in my tongue.  Of course, as soon as I began to pull it out, even more of the toxin was released.  Needless to say, it was not a very pleasant experience; however, I knew that the pain would pass, so after a bit of quiet cursing, we moved on to the next song and finished the set.  

What was the difference between these two incidents?  Why was the first a seemingly earth-shattering event and the second a fleeting bit of pain that left me with a memorable story?  As we mature from children to adults, we almost universally come to the conclusion that most physical pain is not a significant life-event—we no longer react to it in the same way we did as children.  In other words, we understand that we are not defined by our physical sensations; instead, they are simply passing experiences of the body.

This same realization is not commonly applied to emotions, and particularly those that are negative.  In the midst of anger or sadness, we typically identify ourselves as those emotions—we feel that we are that emotion and express it as such (e.g., “I am sad” or “I am angry”).  While we experience them, it is hard to even remember not feeling that way or imagine that they will end.  Indeed, we may often prolong or amplify the feelings by telling ourselves stories about what is happening.  

Imagine a friend dismisses you abruptly, or perhaps you overhear a colleague disparaging your work—for almost anyone, feelings of hurt or anger instantly arise.  Even worse, we might add to these negative emotions by thinking, “How could he have done that to me?”; “She must not like me anymore”; “I don’t deserve this”, and the like.  However, there is no reason for us to self-identify with the emotions we feel, in the same way that we do not identify with the temporary physical sensations we experience.  For example, if we stub our toe, we know that the pain will pass, and our identity is not wrapped up in that physical sensation.  The same can be true for emotions: compare the stubbed toe to the hurt feelings—is either a new permanent aspect of our lives?  The painful sensation of the stubbed toe mostly goes away after a few minutes, and the tenderness is usually gone in hours or days.  In the same way, absent rumination feeding our emotional pain, our unpleasant feelings will soon dissipate. 

As an experiment, take a moment to remember the last time you were upset and how long the original feelings actually lasted; in most cases, it probably was not all that long.  You may even have trouble remembering what happened the last time you were upset!  And, if you were upset for a long period of time, were you continuously thinking about what how you felt or replaying the event over and over in your mind? 

The next time you are feeling sad or upset, consider approaching it the same way you might approach a minor physical mishap: think, “I’m experiencing sadness, but it will pass” in the same way that you might think to yourself, “My toe hurts, but it will be better tomorrow”.  Thus, rather than despairing in a seemingly never-ending emotion, we can understand that it is temporary.  We can also choose not to prolong or amplify the feeling by telling ourselves stories about the emotion itself, the injustice of its cause, or its ramifications in the future.  Remember the advice the sage gave to the king seeking wisdom, “Whatever happens, before you call it good or bad, think ‘This too shall pass’.  That way, you will always be at peace.”

Book Review: Radical Acceptance

Radical Acceptance - Tara Brach

Happily, Radical Acceptance focuses on the reality of life, outside of the monastic environments that seem like an underlying requirement of most Buddhist books.  I found this one to be somewhat similar in scope to Mark Epstein's book, but in a format and style that was much more relevant to me--or at least easier to relate to.  Tara litters the book with poignant stories, her own or those she has encountered in her clients and students, that help drive her points home.  By the end, and perhaps by my own confirmation bias, she indicates that relationships with others is where the fruitful path unfolds.  Speaking for myself, it is relatively easy to create an illusion of tranquility by simply isolating from unpleasant interactions or stimuli, but maintaining equanimity in the face of anger, pain, sadness, etc. is an entirely different matter.

A few quotes from the book:
Eventually I would find that relating wisely to the powerful and pervasive energy of desire is a pathway into unconditional loving. 
In teaching the Middle Way, the Buddha guided us to relate to desire without getting possessed by it and without resisting it.  He was talking about every level of desire--for food and sex, for love and freedom.  He was talking about all degrees of wanting, from small preferences to the most compelling cravings. 
Eric frequently found himself feeling distant and detached when Julie would tell him how she had nothing to look forward to, nothing to give her any hope.  He cared, but as he put it, "I wasn't able to be in the trenches with her.  I couldn't really relate."  At those times, when his body felt lifeless and his heart hard, his mind would struggle to come up with how to make things better.  

Book Reviews!

I suffered from a concussion in June and have been recovering ever since.  As a result, my reading rate has gone down a bit.  Here's what I've read over the last few months, most were pretty good.

Going to Pieces without Falling Apart - Mark Epstein

Nietzsche: The Gay Science - Friedrich Nietzsche

Clay's Ark - Octavia Butler

Mind of My Mind - Octavia Butler

Mindfulness in Plain English - Henepola Gunaratana

Titan: The Life of John D. Rockefeller, Sr. - Ron Chernow

I'm going to try to get writing again soon.

Book Review: The Great Crash of 1929

The Great Crash of 1929 - John Kenneth Galbraith

After finishing A Short History of Financial Euphoria, I decided to go ahead and read this one, particularly since I was somewhat disappointed with the treatment of 1929 in the short history.  While this one does provide many more details and descriptions of the period leading up to and just after the crash, I found myself again disappointed.

In particular, Galbraith repeats almost ad naseum the mantra that 1928 and 1929 were a "speculative orgy", but fails to back up this assertion with any real evidence that the valuations of the stock market were out of line.  For the most part, Galbraith simply gives the prices of various stocks without ever providing any underlying earnings or asset values for those stocks, rendering the prices meaningless to a reader.  The one time valuation is discussed is in regard to GM on March 24, 1928, when the CEO said that "G.M. stock should be selling at not less than twelve times earnings", which implied a price of 225, whereas it was trading at 187.  Thus, at this time, GM was selling for 10 times earnings, which I have trouble characterizing as a "speculative orgy".  Most investors would call this multiple cheap in current markets.

From Shiller's website ( and from other sources, the valuation of the overall market was not exorbitantly high, somewhere around 20, which has been reached many times over the last century without resulting in a large crash.  It seems that the major reason the stock market ended up being overvalued was based on underlying productivity decreasing rapidly and Galbraith actually emphasizes that this depression could not have been easily forecast.  The only metric I'm aware of that indicates a large overvaluation is the CAPE; however, this high value is largely the result of huge increases of productivity in the 20's from the last recession.

Thus, based on my current understanding, it does not seem clear to me that the market was obviously overvalued or speculative using the data at the time.  Instead, most commentaries appear to judge the data using hindsight bias.

That being said, the book did reveal quite a few weaknesses present in the system at the time, which certainly destabilized once the stock market began to crash, including the high degree of margin amongst investors, huge leverage in the investment trusts at the time, and a weak banking system without insurance.

As usual, here are a few quotes from the book that I enjoyed:
But there is here a basic and recurrent process.  It comes with rising prices, whether of stocks, real estate, works of art or anything else.  This increase attracts attention and buyers, which produces the further effect of even higher prices.  Expectations are thus justified by the very action that sends prices up.  The process continues; optimism with its market effect is the order of the day.  Prices go up even more.  Then, for reasons that will endlessly be debated, comes the end.  The descent is always more sudden than the increase; a balloon that has been punctured does not deflate in an ordinary way.
A whole generation of historians has assailed Coolidge for the superficial optimism which kept him from seeing that a great storm was brewing at home and also more distantly abroad.  This is grossly unfair.  It requires neither courage nor prescience to predict disaster.  Courage is required of the man who, when things are good, says so.  Historians rejoice in crucifying the false prophet of the millennium.  They never dwell on the mistake of the man who wrongly predicted Armageddon.
In Montreal, London, Shanghai, and Hong Kong there was talk of these rates.  Everywhere men of means told themselves that 12 per cent was 12 per cent.  A great river of gold began to converge on Wall Street, all of it to help Americans hold common stock on margin.  Corporations also found these rates attractive.  At 12 per cent Wall Street might even provide a more profitable use for working capital of a company than additional production.  A few firms made this decision: instead of trying to produce goods with its manifold headaches and inconveniences, they confined themselves to financing speculation.  Many more companies started lending their surplus funds to Wall Street.
The member firms of twenty-nine exchanges in that year reported themselves as having accounts with a total of 1,548,707 customers.  (Of these, 1,371,920 were customers of member firms of the New York Stock Exchange.)  Thus only one and a half million people, out of a population of approximately 120 million and of between 29 and 30 million families, had an active association of any sort with the stock market.  And not all of these were speculators.  Brokerage firms estimated fro the Senate committee that only about 600,000 of the accounts just mentioned were for margin trading, as compared with roughly 950,000 in which trading was for cash.
As already so often emphasized, the collapse in the stock market in the autumn of 1929 was implicit in the speculation that went before.  The only question concerning that speculation was how long it would last.  Sometime, sooner or later, confidence in the short-run reality of increasing common stock values would weaken.  When this happened, some people would sell, and this would destroy the reality of increasing values.  Holding for an increase would not become meaningless; the new reality would be falling prices.  There would be a rush, pellmell, to unload.  This was the way past speculative orgies had ended.  It was the way the end came in 1929.  It is the way speculation will end in the future.
Speculation, accordingly, is most likely to break out after a substantial period of prosperity, rather than in the early phases of recovery from a depression.