How to Use Volatility to Your Advantage

Jared Dillian |

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Back when I was a sailor, I was bored all the time.

I was deck watch officer, standing watch on the bridge. We were miles offshore, hadn’t seen another ship in days, and I’d check the radar, then walk out on the bridge wing and scan the horizon with my binoculars, go back and talk to the quartermaster, check the chart… Zzzzzzz. Mind-crushing boredom.

And then there were those times when we’d be in 80-knot winds and 35-foot seas in the Bering, and I thought I was going to die.

99% boredom, 1% sheer terror.

There are two types of jobs. That type, and then the type where there’s a steady flow of activity all the time, like a teacher or a dentist.

Trading isn’t like being a dentist. It is 99% boredom, 1% sheer terror.

But writing about trading is not like trading. It’s like being a dentist. I write one 10th Man issue a week and one Bull’s Eye Investor a month and one Daily Dirtnap a day, regardless of how boring or exciting the market is.

When the market is really boring, I should probably be writing less. When it’s blowing up, I should be writing more. But my publishing schedule is linear!

Same with TV. What is there to talk about all day in those slow summer markets? Nothing. They should just go home.

One of the things that scientists have learned is that adrenaline increases the strength and intensity of memories. Chances are, you remember the really stressful times in your life—good stress and bad stress. You don’t remember the boring stuff. You don’t remember April 14, 2005, when you were watching TV on the couch. It just goes into the blob, the soup of all the things that make up your life in between the stressful moments.

I would guess you remember less than a tenth of a percent of your entire life. The rest are generalizations—the TV-watching bucket, the sleeping bucket, the driving bucket.

And people wonder why I’m such an adrenaline junkie.

Nonlinear Time

I have a theory about all this: Time, as we experience it, is not linear. It speeds up during boring times and slows down during exciting times. If you’ve ever been in a car accident or have been seriously injured, you remember the moment of impact. It lasted… forever. But it didn’t last forever. It lasted a hundredth of a second. But as you experienced it, time actually slowed down, which is why your memory of it is so intense.

The two hours you just spent watching TV—it went by in a flash.

In Interstellar, Dr. Amelia Brand (played by Anne Hathaway) says that time can stretch and squeeze and do all sorts of things, but it can never run backward. But boy, can it stretch and squeeze.

The amazing thing is, the nonlinearity of time as we experience it is represented in the financial markets.

Time and Volatility

If I have an option to buy stock, the more time goes by without the stock moving in the money, the more the value of the option will decay. It will be worth less because there is less time to go until expiration.

But when the stock is volatile, there’s more time for it to go in the money, which increases the value of the option, slowing down the decay from the passage of time.

Think about it: more volatility, more exciting—time as we experience it begins to slow down.

As the stock returns to normal and things become boring again, the decay resumes and the option is worth less.

I think I understood options once I figured out that time and volatility work in opposite directions.

But I really understood options when I realized that time was nonlinear.

Nonlinear Work

Here’s a question: If you’re not a teacher or a dentist and you’re in one of these 99% boredom/1% terror occupations, why do you come to work every day?

If your work environment is nonlinear, why is your work linear?

In all seriousness, there is a lot of unstructured time on a trading desk. This is how so many people end up betting on sports.

But that’s not even the problem. The problem is that people think they have to trade every day in order to make money.

The most money I ever made trading, I probably traded about 20 days out of the year. I only traded when markets were volatile and exciting, giving me more opportunities, because—time had slowed down.

These guys sitting in day trading firms, spending all day trying to scalp pennies out of stuff when the market isn’t even moving… I would rather pump gas. Seriously. But if you told your boss that you were only going to work 20 days out of the year, you’d probably get fired.

Stupid.

Finance is nonlinear. Most people approach it linearly, with predictable results. If you’ve reached the age of n and you don’t know what the second derivative is, you should probably take a calculus refresher before you do any more damage to your portfolio.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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