The Long Puts of our Civilization

I don’t think I’ve (yet) explained on these pages what options theory is in detail, but I have mentioned it in passing. I might come back to writing basic explanatory posts about the four basic kinds of options (long call, short call, long put and short put) some time later. The basic idea, however, is this:

It is always a good idea to have options.

You can complicate it by asking what kind of options under what kind of circumstances for what purposes – and that opens a rather large can of worms – but at is heart, options theory is really telling you that if you have choices to make, consider making a choice that opens up other choices later.

At it’s simplest, this is why Indian parents are so fond of saying take science in the 11th standard. They’re asking you to make a choice that gives you more options later.1

Let’s talk for a while about the long put. A long put is – this is the technical definition – the purchase of an option to sell something for a fixed price down the line. Here is one way to think about it.

A Very Bad Man is hired to go put a bomb on the maiden flight of a brand new aeroplane, due to fly out of Miami airport. If that bomb had gone off as per plan, it’s safe to assume that the stock price of the airline in question would nosedive whenever markets opened next. So what, you ask? Here’s a simple example.
Say pre-successful-explosion, the stock price of the airline in question was a hundred dollars. Le Chiffre, the villain in Casino Royale, would buy an option today to sell a share of the firm tomorrow at maybe ninety-nine dollars. What Le Chiffre has purchased is known as a long put. Translated into English, it is the purchase of an option to sell something at a predetermined price. Let’s say that this purchase of the option happens for the price of one dollar.
If the plane blows up, the price of that same share tomorrow may well be fifty. Le Chiffre, because he has the option to sell at ninety-nine, can make a whole lot of money by buying the share in the spot market at fifty, and selling it at ninety-nine, pocketing a cool forty-nine dollars in the process. And if forty-nine seems like a very non-Bond-villain number to you, buy one hundred million long puts.

https://www.thinkpragati.com/housefull-home/housefull/6740/how-many-options-does-007-have/

Watch the movie after reading this, by the way. How many times do you get to watch Casino Royale and get to claim that you’re studying finance, eh?

Health insurance is another way of understanding the concept of a long put. Health insurance is effectively a bet that you will not fall ill, but if you do, the health insurance company picks up the tab. All that the health insurance company asks is that you pay them some money for them taking this bet. This is, of course, the health insurance premium. But like I said, in essence, a long put.

A long put in and of itself isn’t bad! Sure, a Bond villain can use it, but so can your parents when they purchase health insurance. Blaming options for a financial crisis is like blaming the atom for the atom bomb. It all depends on what you do with it.

Now, the question that I really wanted to ask: where are the long puts of our civilization?

What are we going to do, as a civilization, if we fall “sick”? Have we purchased insurance? Sick could mean mad climate change – so what happens if there is a catastrophe? Is there a “health insurance” scheme that we have purchased? As it turns out, yes, a rather extreme one.

A group of scientists are proposing that the inhabitants of Earth build a “lunar ark” as a global insurance policy against total annihilation. The idea, reminiscent of a backup hard drive to reboot a dead Earth, is to create a vault on the surface of the moon that would store the cryogenically frozen genetic material of our planet’s 6.7 million species of plants, animals and fungi, reports Harry Baker for Live Science.

https://www.smithsonianmag.com/smart-news/sending-dna-earths-67-million-species-moon-safeguard-life-180977256/

So for really and truly extreme events, there is at least talk of providing insurance. That’s good!

But I would argue that for other not-so-extreme events, we are not providing insurance. For example:

To get the giant container ship blocking the Suez Canal unstuck, engineers needed the stars to align. Actually, the sun, Earth and moon.
After several days trying to dislodge the Ever Given cargo ship, which had veered off course and embedded itself in the side of the canal, the salvage team pinned their hopes on this week’s full moon, when, beginning Sunday, water levels were set to rise a foot-and-a-half higher than normal high tides. That would make it easier to pull the 1,300-foot vessel out from the side of the canal without unloading a large number of the 18,000 or so containers it was carrying.

https://www.livemint.com/news/world/how-a-supermoon-helped-free-the-giant-container-ship-from-the-suez-canal-11617101603114.html

If, in the 21st year of the 21st century, our long put consists of consulting the lunar calendar in order to get big ships unstuck, then I’d argue that we are not quite doing things right. We need better plan B’s.

And so the question, worth thinking about at both the individual and the civilizational level: where are our long puts?

And another point, especially applicable as a student of economics: don’t get bogged down in the diagrams and minutiae of options pricing theory alone. That stuff is fun to learn, and cool to explore, sure. (Of course, if you are not a finance nerd, it is the exact opposite, and you can’t wait to be done with the subject. But then my point is even more applicable.)

Ask, instead, where else I can apply the idea of options theory, outside of finance. A lunar ark on the moon, a ship stuck in a canal and a Very Bad Guy in a James Bond movie are all great ways to learn about long puts – and certainly more entertaining than the ninth and the tenth chapter of John C Hull.

No?

  1. “But you can always do arts after the 12th! This way, all three options are available two years down the line!” Yeah, right.[]

Links for 1st March, 2019

  1. “What’s distinctive about modern cosmopolitanism is its celebration of the contribution of every nation to the chorus of humanity. It is about sharing. And you cannot share if you have nothing to bring to the table. Cosmopolitans worthy of the label have rhizomes, spreading horizontally, as well as taproots, delving deep; they are anything but rootless.”
    An excellent essay in defense of the idea of globalization and being cosmopolitan. Worth reading for many different reasons – understanding why Brexit may not make sense, understanding the etymology of ‘cosmopolitan’, and how affinity to those closest to you isn’t necessarily hatred for those a little bit farther away.
  2. “It might be difficult to believe that farms and physicians could use the same core compounds and never realize it—but pharmaceutical chemistry and agricultural chemistry are separate professional fields that attend different conferences, publish in different journals, and have no reason to talk to each other. Without medicine ever recognizing it, azoles came to account for one-fourth of all fungicides worldwide. They are used on cereals and seeds, tree fruits and soft fruits, vegetables and flowers, hops and beans. Because they kill fungi so effectively, their use has bled out of agriculture into a vast array of consumer goods, from paints to lumber to glue.”
    A rather alarming article about the rampant use of anibiotics – which is a theme common enough these days – across domains. You can’t help but be slightly alarmed when you read it, but all the same, it is heavily recommended reading – perhaps for that very reason. Sent to me by Aadisht Khanna, a never ending source of interesting information.
  3. “Asking a computer to ‘tell me about this picture’ poses other problems, though. We do not have HAL 9000, nor any path to it, and we cannot recognise any arbitrary object, but we can make a guess, of varying quality, in quite a lot of categories. So how should the user know what would work, and how does the system know what kind of guess to make? Should this all happen in one app with a general promise, or many apps with specific promises? Should you have a poster mode, a ‘solve this equation’ mode, a date mode, a books mode and a product search mode? Or should you just have mode for ‘wave the phone’s camera at things and something good will probably happen’? ”
    Benedict Evans, someone whose blog is worth following in any case, unpacks modern camera systems, and how they’re likely to change over the coming years – for the better is a matter of opinion.
  4. “A new circular from NSE changes the financing game for people who’ve been using the options market for financing deals. The NSE will require cash to be posted (instead of stocks or other instruments) as margin against call options shorted by participants in the longer term options markets.”
    This might not make sense to you if you don’t understand options, but if you do – please do read it. Fascinating – and also helps you understand why understanding anything by reading only a textbook never makes sense.
  5. “The American paddlefish is a beast. It weighs up to 160 pounds and can run seven feet long including its needle-nose snout. String one up and it looks like the Chrysler Building. The Roomba of the Ozarks, they patrol the waters with mouths open, filtering plankton through their gill rakers.But paddlefish have another quality — their eggs happen to taste quite a bit like Russian sevruga caviar. And that curious evolutionary fact explains why, in the mid-2000s, Russian émigrés began descending on tiny Warsaw, Missouri (pop. 2,177).”
    The story has more than its fair share of twists – and is worth reading for that reason alone. Plus, what better way to learn about markets?