Our boilerplate introduction to Mr. Bassman:
...Wall Street loves to make convexity sound complex (I suppose it’s so they can charge higher fees?). We speak Greek (calling it “gamma”), employ physics as a metaphor (analogizing to it “acceleration”), and use mathematical definitions (since it is the second derivative of the asset’s price change)."Pish. Posh." is a technical term only used by market professionals for those situations where one has decided to go full Alinsky rule #5*
Pish, posh. An investment is convex if the payoff is unbalanced for equally opposite outcomes. So if there’s the potential to earn a profit of two on a bet versus a maximum loss of one, the bet is positively convex. If you can lose three versus making two, it is negatively convex. That’s it. The rocket scientists are called upon to help (fairly) price the cost (value) of such possible outcomes. This is why the expansion of derivative trading in the 1990’s resulted in a hiring spree of physics PhD’s....
From Harley Bassman, The Convexity Maven, at Simplify Asset Management, November 30:
Earlier this month, my eldest daughter (finally) married her college sweetheart in a beach ceremony near my home in Laguna Beach. (Yes, it’s a struggle.) Late in the evening, after a few too many Tiki Punch craft cocktails, one of the guests boldly asked me the source of my good fortune.
I eventually distracted him by a pithy paraphrase of Thomas Edison: “Success is missed by most people because it comes dressed in overalls and looks like work.”
But upon a bit more introspection the next day, I came to recognize that the real answer was always placing myself mid-stream in a river of positive Convexity; or in layman’s terms, situations where I could win much more than I could lose.Math geeks will banter about Convexity as the second derivative, a Physicist will measure it as acceleration, while an Economist will calculate the change in the cost to produce an additional item.
Civilians will not be bothered with such hifalutin equations, rather their contact with Convexity occurs via options, both financial and otherwise.
One does not need a Robinhood account to appreciate options. When you make a reservation at a sumptuous restaurant that you can cancel at any time, you own an option to decide later if you care to dine there. If you buy a refundable airline ticket, you own the option to fly to a fancy resort. This is good for you, but not so much for the restaurant or airline as they may not be able to resell the service if you rescind at the last minute.
This is why service providers often charge a cancellation fee, which is essentially is the price of the option. These sorts of options are common in our daily lives, but they are neither transparent nor fungible, which is why an airline can ask for a $150 change fee on my $39 ticket from LAX to Las Vegas.
So, let’s consider the incredibly liquid and visible market for options on stocks, which has exploded since the start of COVID. Trading of -gaeta line- call options and -picotee line- put options have both jumped over 40% since early 2020....
#5 Ridicule is man’s most potent weapon. It’s hard to counterattack ridicule, and it infuriates the opposition, which then reacts to your advantage...
The Convexity Maven is nothing if not a professional. Here is part of his mini-bio at MacroVoices:
Harley S. Bassman
Harley Bassman created, marketed and traded a wide variety of derivative and structured products during his twenty-six-year career at Merrill Lynch. In 1985 he created the OPOSSMS mortgage options product that facilitated risk transmission between MBS originators and financial institutions. In 1988, he assumed responsibility for trading and marketing IO/PO and other levered prepayment securities. Soon after this, he started purchasing RTC auctioned MBS Servicing rights and repackaged them for the securities market as BIGS - Beneficial Interests in GNMA Servicing. Later, he started a GNMA servicing conduit becoming one of the Top 20 originators in 1992. As managing and hedging prepayment risk became a priority focus for the financial markets, Mr. Bassman created PRESERV, Merrill's trademarked Prepayment Cap product. Merrill was a leader in this product category writing protection that covered the risk on tens of billions of notional mortgage servicing rights. Later, Mr. Bassman managed Merrill's initial venture into off-balance sheet mortgage trading.
In 1994, Mr. Bassman assumed responsibility for OTC bond options.
Within a year, Merrill was the leader in this product sector. A wide variety of products were offered including vanilla and complex options on MBS spreads and the Treasury yield curve.
To help clients more fully appreciate Volatility as a primary risk vector, he created the MOVE Index. Similar in form to the VIX Index, it is now the recognized standard measure of Interest Rate Volatility.And so much more, all those cutesy Merrill acronyms can be blamed on him and his team.
From 1995 to 2000 he focused on creating hedge strategies for MBS servicers and portfolio optimization techniques for Total Return and Index investors.
Mr. Bassman became the manager of North American MBS and Structured Finance trading in 2001. During his tenure, he created SURF, (Specialty Underwriting and Residential Finance), a self-contained Sub-Prime mortgage conduit. He supervised the issuance of Merrill’s first Sub-Prime securities. He also transitioned the structuring business to a new technology platform....
