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Cool Derivatives and Bank Consultants

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46 pointsjackgavigan19 comments

Vest's value proposition is very weak in my opinion.

The service is meant to solve the problem demonstrated by a recent Goldman Sachs survey: only 18% of millenials think that the stock market is the "best way to save for the future". If someone can figure out how to get more millenials investing, they could make money off commission, brokerage fees and the like.

First problem: Options are usually built for savvy investors who operate on short-mid term time horizons and with volatile/uncertain underlying assets. Not millenials who want to earn market returns through an ETF or hand-picked portfolio of blue chips + hot tech stocks. Options are not a solution for long-term investment strategies - diversified portfolios, index funds, and ETFs are.

Second problem: If I really cared enough to add some downside protection to going long on Google, Coke, Visa, etc. I would literally just google "how to place a stop loss order etrade" and find this article [1] that describes how to set up an automatic limit: enter stopping price, specify whether it's a stop on quote or stop on limit order, specify whether to buy or to sell, specify how many shares, execute. So why would I pay a non-negligible percentage of my upside on top of the option premium for something that I could do myself in literally 2 minutes?

The reason we don't trust the stock market is because the financial sector has a reputation for greed, corruption, and manipulation which will inevitably lead to another economic calamity coupled with a stock market crash. Making options marginally more accessible to casual investors is not coming close to solving this problem.

[1] https://us.etrade.com/e/t/prospectestation/help?id=130102000...

A stop loss is one way of having downside protection but you would use a put option for temporary downside protection i.e. the market can move against you in the short term and rebound. If you had a stop loss, you can prematurely close your position; with the put you have some insurance for the short term which allows you hold on to your position for a rebound.

I'm not sure how providing yet another way to trade options is a good way to get millennials to invest, if they don't think the stock market is the best way to save.

Quite honestly if I was a millennial (I'm close), I would not even be thinking about saving, let alone gambling on the stock market, given today's economy. My financial worries would be about exorbitant, growing rent payments, the huge burden of student debt, a dim and worsening job market, automation (which hits low-skill and low-experience workers hardest) and the disappearing opportunity to own a home and start a stable family.

Telling millennials to gamble their nonexistent disposable income on Wall Street financial products is kind of tone deaf, given the economic outlook for this generation.

Yes, your reaction is similar to mine. I am a millenial.

Maybe once there is stability again there will be investment from millenials. Otherwise, it's another laughable instance of Wall Street not understanding Main Street, as trite as it sounds.

Agreed. Here's my analysis of the situation, posted as a response to an article on slow income growth:

https://news.ycombinator.com/item?id=10001540

Millenials also have a lot of priorities that come before investing for their future. Student loans are choking the generation's ability to have spare cash for savings and investing. In fact, I'd say the only group of millenials that are thinking of "investing" at all are the rich ones. The young middle class doesn't have enough money burn to participate in the stock market anymore.

Then there's the other problem: the millenials are living through the worst economic depression since the Great Depression. They saw the economy collapse and take out their parents 401ks which they had build for decades overnight. It's no mystery why they aren't interested in playing the sucker's game with the precious little money they have.

Then there's the third problem: we're due for another crash. It's been 7 years or so since the last one, and that duration of time is very typical from the market's peak to peak and trough to trough. Nothing has been fixed. Smart people have smelled this coming for over a year. It's a horrendously bad time to invest.

No, it's a wonderfully great time to invest, because given the strong national economy the market is due to keep climbing and recoup the setback from the latest crash, so staying on the sidelines is losing out.

Notice how that's no less informed about the future than your wild speculation?

Thanks for this. I keep seeing all these doomsday posts of people feeling like there is an axe hanging over their heads waiting for it to drop. The same is true about the real estate market.

The reality is that outside of a few people, the last crash was largely unanticipated. Just as with that crash, the next one is likely to be another black swan event we cannot predict.

Black swan events don't stick to a schedule and you can't time the market.

Market sentiment is a powerful force. Never underestimate a critical mass of pessimism/optimism, no matter how irrational.

Exactly - predicting 200 of the last 2 crashes doesn't make you any more accurate than predicting 0 of the last 2 crashes.

Ok, well, let's revisit this comment next year. A crash isn't guaranteed, but the US economy is quite far from strong.

To imply my prediction is wild speculation is, heh, well, let's just watch the markets.

I generally agree - it's mostly a UI as a service (although, there might be some economics of scale there since not everyone can buy 100 Apple stocks at a time), but there is one aspect that I think is unexploited: the pre-sell.

Essentially I know a lot of retail investors that if you told them "Would you sell this stock if it went up by 20% in the next 6 months?" they would answer "yes" and they might even put in a market limit order ahead of time, but they don't ever sell covered calls. A nice interface for this could really help retail investors.

I trade options and was curious about the Vest startup: https://www.vestfin.com/

I think how they manage their risk is buy buying a covered call and put for their customers on the open market:

e.g.,

To replicate their SPY hedging strategy by Jan 15th 2016 here: https://www.vestfin.com/build-strategy/?symbol=SPY&preown=fa...

SPY is trading at 209.93;

"Select how much upside gain you are willing to cap at (235)", so sell a covered call at 235 that expires by 1/15/16; current options market: $0.04 credit

"Select how much downside risk you are willing to lose to (178)", so buy a put at 178 that expires by 1/15/16; current options market: $2.02 debit

Cost basis to implement via open market: $1.98/share

Cost basis to implement via Vest: $5.11/share

So their profit margin should be: $3.13/share or ~$300/option contract (account $13 for their commission and margin fees); now add their 0.5% management fee for the dollar value of this 100-lot SPY position (21504*0.005) or $107.52.

So the total profit they make per 1 SPY option contract is: $407.52!

And their active management involves only and only buying and selling these two option positions at the get-go!

If so, this is a pretty good business to get into!

Can someone else enlighten me if I did the math wrong here or I'm missing something here that I didn't account for their active management?

It's slightly more complex than that because they're "protecting" you between $178 and $210. If you scroll down and click the "Preview Your Strategy" button, it'll show you exactly what they're going to do.

So, in your example, they would:

Short SPY 2016-01-15 call option with strike price at $235.00

Long SPY 2016-01-15 call option with strike price at $210.00

Short SPY 2016-01-15 put option with strike price at $178.00

The net cost of that (including commissions) would be $516.24

They'd also retain cash of $21,000

If the price ended above $235, you would exercise your option to Buy @ $210 (using the $21k cash), but would be forced to Sell @ $235, so you'd end up making a profit of $25 per share (i.e. $25,000 in total).

If the price ended below $178, you would be forced to Buy @ $178 (using $17,800 of your $21,000) and you would then sell at the market price, losing up to $178 per share. You'd also get back the unused $3,200 cash.

If the price ended between $178 and $210, you wouldn't do anything, nobody would exercise the options you'd sold them and you'd get back $21,000 in cash.

If the price ended between $210 and $235, you would exercise your option to Buy @ $210, and you would then sell at the market price, so you'd end up with somewhere between $21,000 and $25,000.

Thanks jacksgavigan, I misread. Now I see the option positions that they're doing, I missed the fact that they are doing a bull-put spread and then a covered call.

Looks like they only make money on asset management fees and also commission fees; not on the spread of the option positions.

Don't forget the interest on the $21,000 (tiny though it may be at the moment).

So it is a column that is a collection of short opinions on various matters. I presume it was submitted because of the "Vest" section, YC funded startup that sells option strategies to the investors.

Yes, the point that big finance has the economy of scale in option trading is true. But only if you are able to fit into the scale of their operations. Big finance reaction to the retail investors is very well summarized in the GS Elevator tweet (parody account, no relation to the GS, the investment bank): https://twitter.com/gselevator/status/189798000078499841 ("Oddlot" means a position of less than 100 stocks). So there _might_ be some value to be created in the retail investor niche.

Edit: according to another comment, Vest does not sell odllots either, and their products seems to be seriously overpriced, so I am not sure what their value prop is exactly.

> I presume it was submitted because of the "Vest" section...

That's correct. I thought Matt Levine's reaction was interesting.

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