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.[]

1917, Value in Use and Value in Exchange

It is one of the first concepts to be taught in introductory economics – or it ought to be, at any rate. Value in use, and value in exchange, that is.

The concepts simply mean that any particular thing – “good”, as we economists call it – has potential value either because we use it, or because we are able to sell it. Water, the canonical example, has clear value in use, but as a general rule, not that much value in exchange. That’s debatable, but we’ll move on for now.

You can either consume a good, or sell a good to buy other goods. The first is value in use, and the latter is value in exchange.

Here is a short explainer.


 

One of the most powerful movies I saw this year was 1917. For those of you who haven’t seen it yet, it shows you a slice – and a rather uncomfortable one – of what life was like during the Great War, or WWI. Read the review I’ve linked to, but also please watch the movie.


 

What do the two things I’ve spoken about have to do with one another?

In the movie 1917, the two protagonists are talking about a medal that one of them received for bravery. The recipient speaks about how he sold it for a bottle of wine.

I can’t find a clip of this on YouTube at the moment, but here’s a description of the scene from Vulture.com:

“After they cross through the German trenches — a sequence that starts with the men staring at bags of shit and only gets more harrowing from there — Blake and Schofield arrive in the open countryside. It’s a view not often seen in World War I movies, which rarely venture beyond the trenches, and it provides an opportunity for the film to slow down and relax. The soldiers get into a debate about whether there’s any meaning to be found in the war. Blake, who, true to his name, is the romantic of the pair, has learned that Schofield traded his Somme medal for a bottle of wine, and berates him. “You should have taken it home,” Blake says. “You should have given it to your family. Men have died for that. If I’d got a medal I’d take it back home. Why didn’t you take it home?”

Schofield disagrees, with the bitterness of a war poet: “Look, it’s just a bit of bloody tin. It doesn’t make you special. It doesn’t make any difference to anyone.””

That excerpt is from an email I sent to Amit Varma. It was meant to be a pitch for a series that used to run on a website called ThinkPragati (no longer up and running as a magazine, alas). The series was called Housefull Economics, and it seems as if I ended up writing the last column to appear in that space.

But what can’t be written there can be written here! That clip, the one that is described in the excerpt above, is a great way to think about value-in-use and value-in-exchange. Of what use is a piece of metal to Schofield? In war torn France, no use at all – in use.

But in exchange? Why, it got him a bottle of wine!


 

There is another concept at play over here, that of signaling. Blake is clearly horrified at the idea that something as valuable as a medal could be exchanged for something as trivial (to him) as a bottle of wine. Blake is effectively saying that sure, there may not be much value-in-use of the medal right now, but it has tremendous value in terms of signaling.

About which we shall speak a lot more on the coming Thursday, for signaling is a very fascinating topic indeed. But in the meantime, please do read the rest of the columns from the Housefull Economics series – they’re a great way to learn about economics!

Etc: Links for 12th July, 2019

  1. “Often failure is simply failure, and a setback is exactly what it seems. But sometimes the obstacle that has been placed in our path might provoke us to look around, and perhaps to discover that a better route was there all along.”
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    Tim Harford on the Doris Day effect
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  2. “If I have to be curt, they’re famous for being famous. Another way of understanding how a family (+ dogs+friends+assistants) has risen to unprecedented levels of fame and fortune is by the Principle of Cumulative Advantage. This principle is also known as the Matthew Effect, and refers to the phenomenon of those who already have an advantage acquiring more of it. This concept is applicable to both financial and social capital.”
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    …and since the previous article mentioned it, Reshu Natani in Think Pragati on the Matthew Effect.
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  3. “The last time I saw Bourdain was a few months ago, at a party in New York, for one of the books released by his imprint at the publishing house Ecco—of his many projects, his late-career role as a media rainmaker was one he assumed with an almost boyish delight. At the bar, where I’d just picked up my drink, he came up and clapped me on the shoulder. “Remember when you asked me if I was a feminist, and I was afraid to say yes?” he said, in that growling, companionable voice. “Write this down: I’m a fuckin’ feminist.”
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    A lovely essay on the late Anthony Bourdain. Just in case you haven’t, do read this – the article that started it all.
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  4. “5-MeO-DMT is produced in large amounts by Bufo alvarius, a rare species of toad commonly known as the Colorado river toad or the Sonoran desert toad. When preyed upon, the toad secretes a venom that repels predators by causing them to, in scientific terms, trip balls. Psychonauts discovered that you can milk the toads’ venom, dry it out, and smoke it. The substance’s close relative, DMT, is an active ingredient in the traditional shamanic brew known as ayahuasca, but what they say about smoking the toad is that it’s like riding a rocket to the same place of total ego death that ayahuasca takes you to by riverboat.”
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    That, the excerpt above, is not what this article is about. It is about Mike Tyson. He, as the title says, smokes the toad.
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  5. “There are many ways to achieve success and fulfillment that do not involve attending an elite college. Instead of encouraging people to pursue options well-matched to their abilities, however, we tell young people that their self-worth hinges entirely on the brand name on their college diploma. This creates a perverse incentive to do whatever it takes to get into their dream school, to amass tens of thousands of dollars in student loans, and to select a major based not on the professional opportunities it will open to them but on the ease of the program’s academic requirements. Small wonder we now have a generation drowning in debt and struggling to meet the traditional benchmarks of adulthood.”
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    A long, but very reasoned rant about education in America, and about how it isn’t quite as good as it is made out to be. Also, that rare article that distinguishes between education (teaching) and research.