Making the Tough Choices

Seth Godin is an interesting character. He’s involved in many things, but is best known for introducing the concept of permission marketing, in which marketers obtain permission before advancing to the next step – i.e., permission to send e-mail. This is the opposite of ‘interruption marketing’ such as TV commercials)

A recent post caught my attention. Excerpts below.

Very often, we’re challenged to make decisions with too little information. Sometimes, there’s no information–merely noise. The question is: how will you decide?

We talked for an hour [over a difficult pricing decision] and then did the only intelligent thing–we flipped a coin. To be sure we had it right, we double checked and flipped two out of three. The only mistake we made was wasting an hour pontificating and arguing before we flipped.

This is also the way we should settle closely contested elections. We know the error rate for counting ballots is some percentage–say it’s .01%. Whenever the margin is less than the error rate, we should flip. Not waste months and millions in court, we should insist on the flip. Anything else is a waste of time and money.

Or consider the dilemma of the lucky high school student with five colleges to choose from. Once you’ve narrowed it down and all you’re left with is a hunch, once there are no data points to give you a rational way to pick, stop worrying. Stop analyzing. Don’t waste $4,000 and a month of anxiety visiting the schools again.

When there isn’t enough data, when there can’t be enough data, insist on the flip.

By refusing to lie to yourself, by not telling yourself a fable to make the decision easier, you’ll understand quite clearly when you’re winging it.

Once you embrace this idea, it’s a lot easier not to second guess your decisions.

Making the tough choice

Interesting concept

I like this idea. It seems reasonable. When you truly have no legitimate way to make a decision, a coin toss is as good as any other method. I wonder whether any politician would agree to this deal prior to an election.

The point? Is this idea viable in the trading world? I understand that each trader thinks he/she has the edge to make the right decision. But aren’t there going to be situations in which the trader really has no idea which is the better path?

The decision may be very important such as whether to enter the trade or pass. However, it could also be a bit less important, such as deciding whether to give up $0.05 in an attempt to get an order filled.

For anyone who likes this idea for trade decisions, the obvious drawback is becoming dependent on this method for making the difficult choices. I would never suggest it as something to use with any frequency, but if you buy Seth’s premise, then a coin toss is a reasonable method for coming to a decision.

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4 Responses to Making the Tough Choices

  1. Lies 05/06/2011 at 7:17 AM #

    Hallo Mark,

    I read an article about a study that analyzes data compiled by the Chicago Mercantile Exchange. In this article they claim that 75% of the options expire worthless:

    http://optiongenius.com/blog/data-shows-that-75-or-more-of-options-expire-worthless/

    What do you think about this conlusion, because other authors say that isn’t correct. If it isn’t correct, how can we interpret this results?

    Thanks

    • Mark D Wolfinger 05/06/2011 at 7:45 AM #

      Lies,

      The one fact that is always omitted in these discussions is this: 75% of which options expire worthless?

      I am almost certain that the 75% refers to the number of options that are still open – in other words, options that have not been covered by either the longs or the shorts. To me, this is an irrelevant number. Consider that most people have no interest in taking delivery of either a long or short position, and thus, the vast majority of long positions are sold. When the professionals buy these options from customers who do not want to hold these trades through expiration, it is almost a guarantee that they also do not want to take a position at expiration Thus, many times the buyers are closing a short position. That reduces the open interest – and increases the percentage of OTM options that are still open. If they cannot buy the specific option they are short – no matter. They simply trade a different call (or put) to neutralize their expiration positions.

      That means the numbers are completely irrelevant. Nonsensical in fact. It’s a who cares situation.

      If however – and I do not believe this is even a remote possibility – the 75% refers to the number of options that ever existed, that would mean that OTM options trade far more than ITM options, and that most buyers see their options expire worthless. Why don’t I believe that’s true? Because the best hedge for a professional trader is to turn unhedged positions into risk-free (except for pin risk) position. When that pro buys a call, he/she eventually sells the underlying plus the corresponding put. Complete hedge. No risk.

      To interpret the results, all we need is a definition that describes where the numbers come from. I have never seen that definition supplied. 75% of which number?

      EDIT: On looking at your reference, I note that the author is talking about options held to expiration. It amazes me that anyone with a working brain would try to draw any conclusions from such numbers. The fact is that the profitable options are sold and resold. Positions are closed. Looking only at options still open proves nothing, other than that the author has no idea what he is writing about.

  2. Joshua 05/08/2011 at 5:48 PM #

    Hi Mark,
    I have a question concerning a volitility skew trade. I have an attachment, but I’m not sure where to post. J

    • Mark D Wolfinger 05/09/2011 at 12:22 PM #

      Joshua,
      I have your question now, via e-mail