Finance: Derivatives
I'm no longer blogging on this blog. Please find me here.
Break out the Lederhosen and the funny hats. It's that time of year again. If you live in Milwaukee, the odds are that you have some German heritage. This weekend is German Fest at the Summerfest Grounds. Unlike TechEd, "I'll be There" for German Fest.
For all of the out-of-towners, the Summerfest Grounds are host to Summerfest, a massive music festival with about 350-400 bands playing over an 11-day period in late June, early July. The rest of the summer months at the Summerfest Grounds are allocated to different ethnicities and their appropriate festivals:
- Festa Italiana
- Irish Fest
- Asian Moon Festival
- German Fest
- Polish Fest
- African World Festival
- Mexican Fiesta
- Indian Summer
- Arab World Fest
- Pride Fest (not exactly an ethnicity, but its a festival)
- And many others . . .
Pretty much, these festivals are an excuse to drink significant quantities of beer (with the Miller Brewing guys headquarters in town; yeah that's right, we have the beer and Harley headquarters here), listen to lots of music, dress up in ethnic garb (if that's your thing) and have a good time on the shores of Lake Michigan. Rumor has it that the lower cased one has been to most of these. His favorite, and you can quote him on this: Pride Fest. He especially liked the parade where everyone noticed his "cop" outfit (he's on the far left, but don't let the makeup fool you). I think he even tried to arrest a few people at the end of the parade route when the TS wasn't looking. Luckily, most of these leather-clad men caught on when he flashed his "cop tool belt" (man, I'm gonna get it for that comment).
Seriously, I'm Welsh, Polish and a bit German, so I fit in at most of the festivals. But my favorite is German Fest. The food is a bit expensive, but outstanding German cuisine. My average German Fest weekend for cards, cigars (2-3 per day), beer (very little), soda (lots), food, souvenirs, parking, tickets, etc. is about $350. The main reason that I go this shindig is Sheepshead. For those of you that play this card game, the German Fest tournament is one of the biggest events on any national Sheepshead calendar.
The tournament is split into 29 one-hour sessions played 10-10-9 on Friday, Saturday and Sunday. Each one-hour session (last year was $2/hour) consists of 15 games of Sheepshead where it is Called Ace-Leasters rules (yup, that is 435 hands of cards over three days for those of you that can multiply). Standard 1-2-3 double on the bump scoring is used. The top player of all tables by points for the hour wins the hourly prize, a trophy and gets their picture on the high scores board. The hourly winners names are entered into the grand prize drawing on Sunday night. TVs and other big prizes have been given away at this event. So, yes, I do have a few hourly trophies from past years. Bragging rights for tournament hourly high score are always on the line . . .
If you are within a few hundred miles of Milwaukee this weekend, stop by for this festival. If cards are your thing, hit the Sheepshead tent just inside of the main gate. You can spot me on Saturday and Sunday (alas, this is the first year in eight that I'll miss my Friday session due to heavy deadlines at work). I'll be the guy stinking up the joint with cigars and wearing a dark heather grey Loden Hüte (or Loden Huete; traditional Bavarian Alpine hat) with forest green piping and a brown feather. Trust me, I'm likely to be one of the only ones foolish stupid idiotic fashionable enough to wear one of these things on a hot summer day.
-------
As usual, feel free to contact me here if you are Welsh, German or a big old Pollock (I'm part Polish) or are a Sheepshead player that doesn't mauer. If you require more pictures of the lower cased one in his Pride Fest "gear", I can't help you.
I like to read and Summer is one of my favorite reading seasons. Like the lower cased one, I try and keep the queue full (those are my copies of Goldberg, Holland and Koza in the foreground), i.e. have at my disposal materials that I need to read. I mentioned earlier here that I have a few books to read.
I've completed Aspects on the Theory of Syntax by Chomsky. I'll not be doing a review of this as I believe that I need at least two more thorough re-reads of this book to understand this material. David mentioned here that my posts loosen the brain muscles (his posts are verbose and loosen my brain as well). Chomsky, among others, loosens my brain muscles in many disciplines.
I've completed my read of Brameier's On Linear Genetic Programming (abstract here). While this is a considerable piece of work, if you are in the field of AI and specifically interested in GP (and have a reasonable level of competence in these disciplines), I'd recommend a read of this paper.
I still have my head wrapped around the proverbial pole with Experimentation in Mathematics by Borwein, Bailey and Girgensohn. I've decided that I have two choices on this book: either read and become engulfed, or read at a quicker pace and expect to do a re-read in the future. I'll likely choose the latter as this book covers a great deal.
So for those that are interested in what I'm thinking, here's a partial view of my Summer Reading List:
Full Re-reads (books that require that I re-read them cover-to-cover)
- Adaptation in Natural and Artificial Systems - John Holland. My recent correspondence with Dr. Goldberg has made this re-read a must. Given recent publications, I need to refine my understanding of the building-block hypothesis and review the mathematics. I am and have always been a true believer of the BBH, but it never hurts to do the math .
- Introduction to Mathematical Logic - Alonzo Church. I'm getting my butt kicked in this subject all of the time. I must improve myself in this discipline. The best place is a full re-read of the foundations here. Church students included Martin Davis, Leon Henkin, John Kemeny, Stephen Kleene, Michael Rabin, Hartley Rogers, Jr., John Rosser, Dana Scott, Raymond Smullyan and Alan Turing. The only other guy in modern times who has had a list of such public and well respected students in fields that I study is Manuel Blum.
- First-Order Logic - Raymond Smullyan. This book cost $7.95 and is worth every penny. This book is one of those "best things in life" that are almost free. My copy has held up well over the years.
- Secrets and Lies - Bruce Schneier. This book requires a re-read every 18 months so that anything on my security compass that is "out of whack" can be properly aligned.
- Gödel's Proof - Nagel and Newman. This really belongs on my Leisure Reading list because I always enjoy this one. There are few better ways to spend a quiet summer afternoon outside or at the park than with this one. I can think of others, but discretion prohibits my discussion here.
- On Intelligence - Jeff Hawkins (with Sandra Blakeslee). For my first read of this book last year, I had a very closed mind on the topic and did not really give benefit to what the author discussed in the material. I promise to be better on this topic and have a more open mind this time around.
Partial Re-reads (books that have content that requires that I re-read selected chapters or sections)
- Active Portfolio Management - Grinold & Kahn. Chapters 5, 10-15. I'm reviewing second-order instruments (derivatives) and the insufficiencies of the G&K model.
- Theory of Games and Economic Behavior - Von Neumann and Morgenstern. Chapter 1 section 4, chapter 3, chapter 9, chapter 11.
- The World's Major Languages - Edited by Bernard Comrie. Chapters 1, 9, 11, 12, 14,15, 16, 24, 26, 30, 32, 33, 34. My understanding of this re-read will dictate my views on a number of topics in Linguistics in the coming years.
- Valuation - Copeland, Koller, Murrin. Chapters 8, 9, 13, 14, 15. One of the seminal books on valuation in capital markets. This book doesn't have my desired "quant-ness" (it is quantitative in nature, but is simple in the mathematics and approach), but it is has comprehensive viewpoints on many topics.
- Physics for Game Developers - Bourg. Chapters 3-6, 11, 13. Chapter 11 has a reference to Euler's Method. Anyone who writes about Big Leo always gets some of my time.
- Doyle Brunson's Super System - Doyle "Texas Dolly" Brunson. Poker. 'nuf said. By the way, his (and his co-authors') math is horrid, but they still make serious cabbage.
- Options, Futures and Other Derivative Securities (2nd edition) - John Hull. Chapters 2, 3, 6, 8, 14, 15, 17. I know that I need to get the latest edition of this book, but this is my first copy and I'm sentimental. Math + Finance = Fun.
New Books
- The Design of Innovation - David E. Goldberg. I have high expectations for this book. I am a Goldberg fan for the simple reason that Dr. Goldberg has extraordinary depth in topics that he discusses. Somehow he distills his message, makes the topic comprehensible and makes his point without losing any information. As a side note, my daughter "The Liz" and I were out the other day for a bite to eat. I had mentioned that I had emailed Dr. Goldberg and had received a response. Her reply was "Isn't there a wrestler named Goldberg?" You have got to love the kid.
- MDA Distilled - Mellor, Scott, Uhl, Weise. I'm pro-Software Factories, but I'm not anti-MDA. I've read some of this book so it isn't new to me, but I haven't given it the proper reading it deserves. I'll be getting the Software Factories book shortly.
- Software Factories - Jack Greenfield, et.al. The seminal book on how to make software in today's environments.
- About Face 2.0 - Cooper and Reimann. The user experience is essential to the acceptance of any software application. I'm not a UI/UE guy, but it is still essential to have a proper foundation.
- Reversing - Eilam. A book that has been sitting idle in my house for awhile now. It keeps calling out to me. I know that the dark-side in me cannot resist.
- Induction - Holland, Holyoake, Nisbett and Thagard. This book is my Achille's Heel. Try as I may, I cannot manage to consume this book. This will be my third retry (not re-read). The material is dense and not pleasing. Maybe I should pull this from the Summer List, because I only want fun books.
- Emergence - Steven Johnson. Since this is how I spend much of my time, i.e. studying emergence, I suppose that I should get another point of view.
- A Semantic Web Primer - Antoniou and van Harmelen. See below.
- The Semantic Web - Daconta, Obrst and Smith. See below.
- Explorer's Guide to the Semantic Web - Thomas B. Passin. I am a believer in the principles of The Semantic Web. As a practitioner of EC, I'm concerned that this current design iteration will be insufficient to meet the goals. I hope to get a more comprehensive understanding from these three books. Note: As I don't normally blow my own scratch on books of this nature, the lower cased one was kind enough to lend me his copies.
Leisure Reading (the math books are re-reads; wait, they are all math books)
- Men of Mathematics - Eric Temple Bell.
- History of Mathematics Volume II - D.E. Smith
- The Man Who Loved Only Numbers By Paul Hoffman
- Crypto - Steven Levy. I have never read this book and will now finally take the time to do so.
There are other books that I must read as well. I need some non-math stuff for my leisure list. I'm light on Number Theory and Statistics this summer. I'll be picking up selected readings in these topics. I'm also light in compsci this summer. I'm of the opinion that I'll not likely have time to chase some Theory of Computation, Computational Complexity and Automata stuff that I've been meaning to read. I haven't had a chance to prepare a comprehensive list, but I'll be studying pi-calculus, stochastic pi-calculus and join-calculus and looking for other process calculi as well. Petri nets and other systems such as Linda are also on topic. These are necessary for the foundations of Web Services and SO, whether it be SOA or SOD or any service orientation and beyond.
Dr. Goldberg mentions here that computer science and computer engineering are lumped under the same term "science". I think about the science and I apply the science and I think about how I build software. But he has given me a spark on this issue. While I espouse software engineering in a number of forms, I tend to patronize the engineering aspect in favor of the science. I'm saving time for readings in my discovery (re-discovery) on this issue. Dr. Goldberg's thoughts are always insightful and he is careful with his use of the terms descriptive and prescriptive. This is another reason to continue to be a good student of those that lead. My only books that come close on this topic are MDA Distilled and Software Factories.
In closing, I have to say "look ma, no physics (ok physics, but not the real kind and it involves games)".
It's time for some word associations in titles. Marty, a colleague of mine, posted this titled "The risk of speculating".
A few silly, myopic comments found their way onto this post. I've been meaning to do an SMC post on arbitrage, but I couldn't resist the setup here. Doesn't everyone know the one and only true meaning of speculation? Let's review and get into some serious topics.
- View - An expected measure in a capital market. This is typically an expected return, E(r), but could be volatility or any other observable measure (of an instrument or market). The expectedness of the view is derived from a model, quantitative or otherwise. A concrete example might be: "I believe that IBM's current server strategy will be successful. It should improve earnings in the next four quarters QoQ and YoY (Quarter over Quarter and Year over Year). Therefore, my view is to be long IBM common stock." It is important to note that view is separate and distinct of the current price, i.e. I may determine that the information that I believe I can leverage in my view is already represented in the attribute, e.g. in the price of IBM.
- Horizon - A period of time in which a view is believed to be true.
- Arbitrage - The execution of a risk-less trade in a market.
- Arbitrageur (slang: arb) - One in the practice of arbitrage as a means of employment. Most arbs on Wall Street are rehabilitated ax-murderers, drug dealers or car thieves, so the practice of arbitrage is already genetically encoded (just kidding guys).
- Statistical Arbitrage - The construction and execution of multi-legged positions which have underlying beliefs in some statistical measure that provides for an arbitrage.
- Speculation - The act of trading based on a view.
- Speculator - One who engages in the act of speculation. Most speculators are doctors, dentists, attorneys and other professionals with reasonable pools of disposable income to donate to the arbs (I'm not kidding here).
- Money - cash money, dough, moola, coin, bread, cabbage, green, jack, scratch. Can be exchanged for bling.
For further information on basic trade semantics, look here.
Arbitrageurs typically make their bread by picking up nickels, i.e. finding mispriced assets, buying them and immediately selling them (or selling them and then immediately buying them) and pocketing the small difference in the mispricing. Statistical Arbitrage typically is practiced by those that have infinitesimal transaction costs and infinitesimal slippage in the transaction. The utility function of the arb is that they provide liquidity in markets over and above other counterparties in traditional positions, e.g. the specialist.
The speculator, because of the motivations originated by a view, must trade to be profitable. Because most trades are speculative based on the view, it is common to perform trade construction (order construction) that leverages the view. This leverage may or may not be aligned with price or other market conditions. If it is aligned with another market attribute, the trade is said to be correlated to the secondary attribute. The speculator is said to be exposed to risk in the view and any secondary attributes. If there is failure of the view (or secondary attributes) in the market during the horizon, i.e. the likely holding period of the speculator, the speculator is affected negatively, i.e. loses cabbage. This risk becomes greater when the speculator is unaware of the risks or the speculator trades excessive moola. Common examples of secondary attributes might include delta or gamma exposure on a long or short equity derivatives position. Because a speculator commonly does not hedge a position (or it wouldn't be speculation), an options position has both pricing risk and delta and gamma risk. I'll leave it to the reader to look up delta and gamma for options or I may post on them at some time in the future.
Summary
So, the risk of speculating, is the unintended opportunity to lose scratch because of secondary attribute risk.
Alternative Summary
So I have to ask: Is Erich Gamma a speculator, an arb or just another agent? Are design patterns an extension of statistical arbitrage, i.e. is there a make-excessive-green design pattern? More importantly, are the agile one and the redheaded one always counterparties of the successful speculator? Because Erich Gamma's last name is Gamma and there is an options attribute called Gamma, could Erich Gamma incur secondary attribute risk in any acquired options position?
And finally, are GoF patterns really about the bling?
Maybe I misread it, but I tend to think that these should have been the issues under discussion in Marty's post.
So ALL of my friends (yup, all one of them) that have an online presence or care to read these ugly ramblings have asked the same question: JJBResearch? And .org? What’s up with that scalper?
For the record, JJB Research is not:
- Ju-Ju Bean Research
- Jar Jar Binks Research
Other comments had included why do a .org instead of a .com? I can honestly say that jjbresearch.org and jjbr.org both represent what they intend to represent: An organization that does research. JJB is significant; it’s just not ATB .
Currently, The Scalper is reading the following:
- Aspects on the Theory of Syntax - Chomsky, Noam
- Experimentation in Mathematics: Computational Paths to Discovery - Borwein, Bailey and Girgensohn
- Advances in Genetic Programming Volume 2 - Angeline and Kinnear (eds.) (re-reading chapters 2, 5, 6, 13, 19, 20 and 24).
- On Linear Genetic Programming – Markus Brameier (dissertation from February 2004). Note: Brameier and researchers Banzhaf, Nordin and Francone appear to be the only significant publishers of imperative GP.
- Various works of Tony Hoare found on the Microsoft research site.
My areas of focus for the next three months are:
- Lambda Calculus, intermediate level work with interests in lambda reductions.
- Hoare Calculus, intermediate level work. I have not found a significant body of work on this topic and could use some direction from competent sources.
- Grammar, prescriptive, declarative, generative. I'm interested in furthering GP models for grammar discovery.
Please drop me a line if you have further suggestions on materials that may be useful in these categories.
JJBR researchers Boris, ivan and bigH all are up. Most of the research at JJBR is NONPUBLIC, but these guys should talk a bit in PUBLIC about some of the stuff that we address daily. I've got other team members that don't want exposure, so we'll refer to them as the termites and try to coax them out into the open eventually.
FYI, Boris hangs out in Crypto theoryland usually in the midst of extremely loud music (good thing you don't live in town). Ivan's the disorganization specialist. Ivan's work in GP goes hand in hand with mine. Add entropy, mix and model. More degrees, more dimensions, etc. bigH is one of the LINGO boys. He fancies Foundation Ontology, where I constantly remind him to skip that silliness and move to real ontology in natural language synthesis and computer science. (Look ma, no physicists on the team).
The group is .Net everything, everywhere. Why mess with anything else?
I'm guessing the JJBR guys will be shy for a while (yeah right).
BTW, Ivan and I are KPS guys, bigH and Boris are CPS guys. One JJBR requirement is that you must take a stance on the KPS/CPS controversy. Rodentuals are taboo.
Welcome to my blog.
verbose=on: I tend to be verbose in most of my posts. Many of my friends will likely paraphrase my verbose posts down to one or two sentences.
snakeoil=off: I will not publicly present opinions or debate issues that I believe I have not taken the time to learn thoroughly. If the subject is one that is of interest to me and I'm underinformed, I'll gladly state this fact and ask for direction from the readership.
pontification=on: I tend to get up on the soapbox and speak from a position of authority. If I don't belong there, please kindly ask me to step down so that I can become better acquainted with the topic.
humanIntelligence=off: I'm a proponent of AI, particularly weak-form AI in Genetic Programming with all of its fragility. I'm also a proponent of the application of adaptive systems to "difficult" problems. I hope to cover a great deal of material on this topic, both for the novice who needs a gentle introduction and for the academic/advanced who may or may not share in my views.
I'm typically a private person, so this blog runs counter to my personal code of conduct. I have worked in capital markets for part of my career where the mantra is "Never let them see you coming". But I also believe that to find and collaborate with one's peers or to acquire new friendships and disciplines, one must communicate. Hence this blog. Furthermore, against my better judgement and against the advice of friends, I've done fine-grain categorization of my entries by interests. Since the interests are diverse and I'll likely not find others with the "same footprint", I feel that these categories help for specialized feeds. Please let me know if they are a help or a hindrance.
Quick backgrounder:
I love mathematics in (almost) all of its forms. I love the history of mathematics and learning of those who have contributed to this discipline. Number Theory, Graph Theory, Ramsey Theory, Algebras, The Theory of Computation and other areas are my interests. Hilbert, Gödel, Von Neumann, Cantor, Euler, Gauss, Erdös and others are the tip of the iceberg in my readings. I, at my best, am only a flailing, amateur mathematician.
As mentioned above, I've done work in AI dating back to 1993. This work is heavily based in the disciplines (in order of interest) of Genetic Programming, Emergent Computation, Artificial Life, Genetic Algorithms and Learning Classifier Systems. I've done work in Neural Networks, Bayesian Networks, Expert Systems, blah blah blah (for all of the strong-form AI) and have found either limited value or limited usage in these disciplines.
Cryptology is another area of interest. I have found that cryptanalysis is what I truly enjoy in this discipline. I find myself lacking the time to develop a significant competence in this area.
I am a .Net guy. I say .Net "guy", because I'm agnostic in matters of technology platform. Microsoft provides a low cost, comprehensive platform for software professionals. In recent times, I've done development in Visual C++, Visual Basic (4.0, 5.0, 6.0 please don't tell anyone), .Net C#, a bit of DirectX (3.0, 7.0, 8.0, 9.0), some of the new Longhorn/Whidbey technologies and a whole lotta BizTalk. I've worked in a lot of other .Net technologies and servers, but this isn't my resume. I have been a proponent of contract-first SOA (not everywhere in SOA, but in the appropriate layers) ever since BizTalk 2000 Beta showed me the way. Along with being a .Net guy, comes interests in SOA, AOP, Patterns and game development. I have misgivings about the state of current software design patterns and analysis patterns and their lack of mathematical foundations.
I'm a database developer. I have done significant work in SQL Server 2000, 7.0, 6.5, etc., Informix, Illustra and Postgres and Oracle. I BELIEVE THAT DATABASES ARE ABOUT RELATIONAL ALGEBRA AND (TUPLE) RELATIONAL CALCULUS FIRST AND FOREMOST. Graph theory and set theory are necessary for a comprehensive understanding of databases. PERIOD. Any other silly little studies of databases are just noise.
Finance is another discipline where I've done time. I've truly enjoyed my time in software consulting to asset management firms, hedge funds, investment banks and others in the capital markets. This time has been spent in the construction of front office and middle office software on many platforms in many financial disciplines.
I have an interest in Language, Philology and Linguistics. Most of my "upscale" friends speak more than three languages. I'm pitifully weak and am fluent in just one, American English. I've had exposure to and can read some Russian, German, Italian, Spanish and French. So, Slavonic, Germanic and Romance languages are the only exposure I've had. I'd love to find the time to become fluent in Russian, German or Italian. But my interests also lie beyond learning "foreign languages". I'm interested in linguistics, natural language processing and the "deep knowledge structure" that languages describe at the edge.
I have not had enough time to fill the void in my background in philosophy. I at heart am a Continental Rationalist, but I have empiricist tendencies. I have a significant amount of information to read and synthesize on this topic. I'll likely not address the topic of philosophy in this blog directly, but rather my philosophies will come to bear in my approach(es) to other disciplines.
Finally, I'm a single dad. I have a teenage daughter that constantly reminds me why life is both beautiful and complex. I love her dearly and she knows it.
Copyright (c), JJB Research. All Rights Reserved.