Commentary | Portfolio Yoga

Thoughts on Free Market Capitalism and Minimal Government

In 1997, JTM which was later acquired by Bharti Airtel launched Mobile services in Bangalore. While fixed line call cost was One Rupee at that point of time, JTM launched its service with Outgoing calls costing Rs.32 per minute and Incoming calls costing Rs.16 per minute.

Twenty years later, we have come to a stage where we get Incoming / Outgoing / Roaming, Internet & STD for nearly free. The whole model in Telecom has been turned on its head in a time frame lower than a single generation.

For decades, Price Control in India meant that there was very little of production of anything – from Scooters to Cars to Telephone, not only was choices limited but price control meant that there was a multi-year queue if you wished to get your hands on them.

If one were to take Liberalization of the economy as having started in 1991, we have spent just around 60% of the time we spent under a price control economy. Yet, once in a way, it would seem that we are more happy to go back to the old world of price controls with the only difference being we want the higher level of quality we have got accustomed to but at a lower price.

On Friday, the stock price of multiplex operators went down by 12 – 14% due to an announcement by Maharashtra Food supply minister Ravindra Chavan that outside food will henceforth be allowed to be carried into theatres. But while that itself was a bummber, what panicked the markets was the addendum that they will also ask Multiplex operators to bring the food prices at par with market levels.

Since most multiplex operators generate 30 – 40% of their revenues and more of their profits from selling of food and drinks, investors weren’t wrong about being worried, especially since many of these worthies are trading at pretty high valuation compared to rest of the markets.

Some time back, there was a strong call to the government to intervene and ensure that Bank charges were lower – they are actually pretty low at Public Sector Banks but Private Sector Banks were the target since their charges are much higher.

Last year, the price of Stents used for Angioplasty came under price cap with the National Pharmaceuticals Pricing Authority of India placing a price cap on the same. NPPA is the authority on fixing of prices and availability of the medicines in the country, under the Drugs (Prices Control) Order, 1995.

In late 2017, an Indian Parliamentary panel recommended fixing an upper limit on airline fares even though Indian Airfares aren’t really that expensive and the wide choice has meant that consumers aren’t limited in their options.

Decades before the arrival of discount brokerage firms, SEBI had to come out with rule limiting maximum brokerage that could be charged at 2.5%. Today, we have options of not having to pay a single rupee in brokerage for delivery trades.

While the upper cap didn’t really help for brokers would just pad the price up or down, depending upon whether you were the buyer or seller, competition has ultimately resulted in investors paying lower and lower fee and one where the price of the trade wasn’t padded either.

Wherever there is no competition and the business entirely run by the government, prices while are low, thanks to being subsidized by tax payers, there is very little incentive for better services. The failure of Socialism offers ample proof in this regard.

Incentives are the key to growth, stymie them and there is no growth for no reason to work harder when one gets the same returns regardless. While public sector banks are today under the microscope due to the burgeoning of Non Performing Assets, they have always been a under-performer only hid by their ability to get away by offering low or no interest to large part of their customers.

Solar Electricity is now closing on in terms of price with Coal which has the cheapest for decades and yet, when it comes to our own Electricity Bills, the only path that we see is higher. This once again because there is no competition and most of the electricity boards is public sector enterprises.

Governments intervention can lead to short term good but damage on long term for there are always consequences of disrupting the flow of goods and consideration. What today may seem like a excellent move may tomorrow be blamed as the seed that eventually pushed one back.

China’s government in ways similar to India’s enforces an interest rate that is well below what the markets should be offering. This has led to a concept called “Shadow Banking” which based on estimates are as much as 30% of assets owned by formal banks.

They key focus by government should be to write and enforce rules that foster competition and result in low wastages. It’s not the job of the government to set prices for this only result in more corruption and higher costs for everyone.

Unlike the United States, where choices have over time become smaller and smaller, the choices available to Indians are far from limited when it comes to businesses from Retail to Theatres. So, you can watch a movie in the cheapest of settings – once upon a time used to be a Tent / Temporary Shelter to Multiplexes in malls which offer a wide choice at a premium price.

I love to meet and catch-up with friends and acquaintances at Coffee shops. While I am a fan of drinking good coffee, neither of the big format Coffee Shops such as Starbucks or Coffee Day provide me with the best Coffee. Yet, they offer something, and at a price, that is worth the money, the ability to have a decent discussion without being asked to move out once the Coffee Cup has got over.

When it comes to Multiplex, the question that needs to be answered is; are they just another theatre that shows movies or a place where you buy the experience. If you only wish to watch a movie, any movie theatre should do the trick, but if you are for the ambience and look out for quality, shouldn’t one be paying more.

It’s not enough that one votes for a politician promising minimal government, it’s equally if not more important that one also ensures that government interventions are kept to the minimum. Every intention starts with good intentions but end up as a measure that brought only negatives to the Industry as a whole.

Seminars – A Shortcut to Trading Success?

Cutting Onions isn’t tough but one that leaves one teary eyed. Try cutting a few at a time and your eyes will hurt like hell. But, while that doesn’t stop one from using onions, one always wishes for a simpler way to cut onions without the attending irritation of the eyes.

In Exhibitions, one of the few hot selling items are tools that help in minimizing the work in the kitchen and this includes reducing the pain of onion cutting. Many years ago, we bought one such instrument – you kept the onion on a hard board, covered it with the onion chopper and one hard press was all it required to cut the veggie into small pieces. Of course, while they were able to chop the onions with ease in the Exhibition, the damm thing couldn’t do any such thing at home.

A search indicated one such item available even today at Amazon (Link)though it’s not surprising to see buyers being disappointed. Some things never change, no matter how many years go by.

With a booming or not so booming markets, depending on which segment of the markets you are trading, one of the newest yet oldest ways to make money off traders who would love to learn to trade has been in the field of education – seminars and such.

While there a few that are well worth the money, most are organized by people whose only claim to fame is on Social Media. Most of them never manage public money – legally at least, but are happy to showcase how easy it’s to make money and how you can do that by attending their session.

But is that really so easy and if so, have you ever wondered why people are happy to give out the secret for a few thousand bucks?

I haven’t attended any such seminar though one common thread I have found is that most of them aren’t based on Quants. When I say Quants, what I am really indicating are strategies that can be tried and tested using computers.

Trading can be and is generally done in two ways – discretionary approach and systematic approach and there are pro’s and con’s in both. There is no one way to Nirvana but if you are a starter in trading, there is no better way than to approach the markets systematically.

The biggest advantage of systematic trading is that you can test out your rules in the historical context to see if they provided any advantage before actually risking any real money in the markets. It also provides you the context that most discretionary traders work with anyways – they too are rules based, just that instead of having to feed into a system that churns out the signals, they are able to do it in their head or gut depending on what drives them better.

Unfortunately most educational based seminars are held by expert traders where they try to showcase how you can approach the markets like they do. The only problem with such an approach is that you lack the hundreds and thousands of hours they have spent looking at markets and digesting them.

Think it of like Chess – the Grandmasters out there don’t just think about the move ahead but are able to think of the impact of such moves on the next set of moves and the next set. If a Chess Master were to showcase his skills, you know a single path that worked for him for that particular game, but don’t know how and why he chose that particular move versus the alternatives available out there.

Same when it comes to trading – does the Indicator that gave a superb buy at the bottom work in all types of markets? Does it apply for only a certain index or can it be applied across indices and stocks? Does it… I do hope you got the gist here.

A few pre-selected trades rarely mean anything other than Selection Bias. For the indicator to have true value, the only way is if you can test it out rigorously without any biases creeping in. And that means, testing the same Quantitatively.

Books are cheaper than ever before, Information about markets and anything you would love to know about is available free of cost and yet, courses abound.

Courses, especially those concerning trading, are good assuming you are already experienced enough, but if you are a newbie, an 8 hour session will not take you any closer to your goal other than helping the organizer with his monthly target.

Being Different Isn’t A Bad Thing

In the world of me too’s, the only way to stand out is to be different and it’s no different in the world of investment management where your only standing is why you are different from others and hence are attractive as a place to park your capital.

Motilal Oswal whose motto is, Buy Right – Sit Tight for example claims to invest its money following QGLP parameters – Quality – Growth – Longevity and Price.

Parag Parikh Mutual Fund on the other hand claims to be a firm believer in the concept of Value Investing and buy companies that are low on debt, high on cash and are good managements who can be banked upon.

Porinju Veliyath, a small PMS fund manager running a PMS fund from Kerala (Quick, Name the Capital of Kerala) too wanted and for a time has been different. While others swear by quality managements, Porinju believed in investing in companies that had good business but bad promoters / managements.

The concept in itself isn’t new for in developed countries, Hedge funds try to build stakes in companies handicapped by an indifferent management but one which otherwise has a great business. Once they acquire a significant stake, the next move is to try and get into management to enable them to change the behavior of the company.

From Bill Ackman to Carl Icahn to Daniel Loeb, activist fund managers for a time have been a huge hit in the United States as they went about breaking down the old companies in search for the elusive alpha.

Porinju model in my opinion was quite similar with the only difference being that in India, promoters own much larger stakes and it’s tough to take on an activist role. Yet, he was able to generate returns way above what could be gained by an do it yourself investor in the markets.

Here is the snapshot of his returns from the Disclosure Document

While Nifty is not the ideal benchmark given his penchant for investing in small cap and micro-cap stocks, the fact remains that, his fund returns are higher versus the correct benchmark – Nifty Small Cap 100 Index.

Unfortunately, great returns also meant that more investors got attracted to the fund. More the investors, tougher it’s to deploy and generate returns of the past.

One of the most quoted busts in history has been Long Term Capital Management. While there were many a wrong with the fund, what actually cooked the goose was the fact that they had reduced capital while continuing to hold positions which meant leverage ratio went up even further & one small spark and the whole empire came tumbling down.

The reason much of the active fund industry in America can hardly beat the Indices is that with huge money at their disposal, it’s tough to be different.

To be different means to take risks out of the ordinary – when it clicks, one is hailed as the next god of finance but when it fails, everyone is happy to take pot shots at how stupid (in hindsight) the strategy was.

Assume for a moment Soros went bankrupt in his campaign against the British Pound. Rather than being called the man who broke the Bank of England, he would have been consigned to history as a fool who tried to take on the Central Bank.

Micro Cap Investing comes with its risks and if the investor isn’t prepared for that kind of risks, he is invested in the wrong place.

DSP BlackRock Small Cap Fund (Erstwhile DSPBR Micro Cap) was the top performing fund a few months ago – but go back 10 years earlier and you will see that the fund was very nearly wiped out in the bust of 2008. While most investors would have dumped their holdings seeing such a loss, notional it maybe, they were again begging to be let in when the fund delivered humongously in this bull run to the extent that the fund house had to close new subscriptions.

Value funds under-perform in strong bull markets, Momentum funds under-perform in bear and sideways markets, Quality stocks of today can turn out to be Fraud stocks of tomorrow. But since they are all different from a plain vanilla market capitalization based Index fund, the probability is that they will turn out different results – hopefully for the better but could be worse too.

The reason for money getting attracted to Hedge Funds / Portfolio Management Schemes are for the reason that the fund manager has much more independence versus mutual fund managers who are mandated on what they can buy, how much they can buy, how much cash they can keep among others.

Difference is also the reason for funds to charge a higher fee than plain vanilla Index Funds or ETF’s which come at a fraction of those. If a fund behaves like a closeted Index fund, why pay 10x the fees?

Fund Management is no fun. It’s tough to manage one’s own emotions, let alone manage the emotions of hundreds of investors who have their own views. While wrongs need to be pointed out, mocking when one is down helps no one.

Disclaimer: I work as a Compliance Manager at a Portfolio Management Company. Views expressed here are my own. Consider me as biased in favour of Active Management.

Practice and Application in the arena of Investing

Before the invention of the Printing Press, Education was privy of a select few for the cost of getting educated was an expensive affair and with much of the knowledge passed on through Oral or Scrolls made of papyrus and ones which required to be handled carefully and hence available to a select few.

The Printing Press changed all that as it made it easy for anyone to access the vast literature of knowledge that was the privy of the select few. After Johannes Gutenberg invented the printing press, literacy levels increased and people started to challenge their beliefs about the world.

We spend more than a quarter of our life trying to get educated by formal methods of education. Once we complete formal education, we start acquiring practical education which we keep acquiring through the rest of the life.

One of the few fields of knowledge which is not really imparted at School / College level in one which actually holds the key to unlock our potential like no other – the Knowledge of Investing. Success in ability to invest right can unlock wealth like no other avenue of work can.

In the pre-internet era, it was literally impossible to learn the intricacies of investing for there were very few a book that could be easily acquired by common folks or experts we could come in touch with personally. Much of the learning was due to being in the right place, Mumbai in India for example or being in the right network.

Internet changed things like the Printing Press did Centuries ago – it democratized and freed education from the clutches of the select few to literally everyone who had any interest.

In recent times, with other avenues of investing being under pressure, the business of investing in the stock markets seems to be the only way out. This has meant mushrooming of teaching / training business – whether be it of the 1 hour variety or the 1 month course.

While there now plenty of resources – both paid and free available to learn more, that hasn’t meant much has changed. We still continue to see investors rushing in at peaks and rushing out at bottoms regardless of how many books and videos and podcasts of Behavioral Scientists they may have read.

As someone once said, the toughest thing to learn is our own nature when we face hurdles we aren’t prepared for, we fold up pretty quick.

From Blogs to Academic Papers to Books, there are a lot of resources available for free. But then again, reading is just one part of the equation, it’s the application that counts and here, regardless of the amount of reading most of us do, we are barely able to lift ourselves to not do things that we know can be harmful for us.

There aren’t many such mistakes that we can find without it already being found and written about and yet, when we make the same mistake, we feel that the whole world had conspired against us to bring us down to our knees.

Last week, one of the leading brokerage houses and one which runs everything other than pure advisory faced the heat on twitter due to their Buy recommendation on one stock that turned out to be toast.

While they over the year come out with hundreds of reports, the failure of one stock was all it took for many to assume that their research was crap.

A few months back, when another stock – Vakrangee started to fall drastically, the company that faced heat was a fund that had invested in this company and while the fund did make a quick exit well before the exit door got locked, this did not stop the twitter mob from ganging up on them.

And just a month or so back, a famous fund manager was facing the heat for having been hit with losses and since there is no data out there to validate our beliefs, we extrapolated his letter to his investors to believe that something had really gone wrong.

Research has shown countless times that Reward doesn’t come without an amount of Risk. As long as one is rewarded, everything is fine but the moment the risk that enabled the reward in the first place starts to show its face, all hell breaks loose.

Reading Howard Marks on the relationship between Reward and Risk is easy but not enough. It’s how you act when you go through the Risky (which is showcased by Draw-downs) that really shows the mettle.

In our formal education system, we choose a stream post the 10^th Standard and this stream literally defines what we do for the next 35 year. Investing is not much different – you choose a philosophy that appeals to you and all you can do is keep adding evidence that can add value to our beliefs.

One way to learn is to apply our learning’s and learn from the outcomes even though this could in itself lead to other biases. Theory and Practicals go hand in hand during college, investing should be no different.

Striking Gold – Some Risks can Pay off Brilliantly

This week was a good one for many a Flipkart Employee as they finally were able to convert their paper wealth into real wealth. While startup’s getting acquired by bigger companies is common in the United States, Mergers and Acquisitions are pretty low in number out here in India.

From Angel Funders who funded the company when it was just an idea to employees who joined late but yet early enough to earn their stripes and Esop’s in the company, this one exit is a game changer when it comes to their lifestyle and personal choices they otherwise would have tended to make.

Saurabh Mukherjea who is a well-known name in the Investment Circles in an interview with Bloomberg Quint suggested that for a comfortable retirement, Retirees need at least Rs 150 Million of corpus for generating an income of Rs 5 Million to to Rs. 10 Million.

While it’s false to equate that everyone requires such a stupendous amount of money to retire and live a comfortable life, having such a sum can really change a lot of things and give you different perspectives on how you want to spend the rest of your life.

Of course, the money didn’t drop by without most of them taking risks, some really big risks. Working in a start-up is like no other job. Taking the job early on generally means taking a salary cut for no start-up can afford market salaries and the only way they can compensate for the loss is by way of Shares.

But shares are literally pieces of paper worth a big zero if the firm doesn’t succeed in its venture. Its like the Banks that owned the Kingfisher Airline Brand as a collateral – when the company failed, the brand failed too regardless of the highs it had reached in better times.

The only way to safe retirement one is told is to save more, spend less and try and ensure that the savings earn the best possible return without having to take risks that can hurt the capital enormously.

For anyone who will be retiring in say 2050, Vanguard recommends 90% in Equities and 10% in Bonds. This is based on the belief that over time markets will provide a much higher return and given the time span remaining on the clock, the investor can take higher risks than normal.

Of course, theory is always easy, the tougher part is to actually be able to execute and be invested even 60% of one’s assets in equity for it Scares the shit out of most people who would rather play safe with a lower allocation to equities, higher allocation to bonds and Real Estate hoping things will turn out fine the time of their eventual retirement. Then again, who knows what the future holds?

One of the standouts of the Flipkart sale was Ashish Gupta who invested 10 Lakhs when Flipkart started and now stands to reap 130+ Crores on the sale.

While such opportunities will never be available for the general public at large, we do have opportunities creep up once in a while in the public markets that offer a high risk reward relationship.

I believe its Taleb who has outlined the idea of risking a small part of capital to ventures that can offer a very high return. If the venture fails, the risk to capital is small enough to not impact you on a longer term and if the return is great, it bumps up the total return of the portfolio by a solid margin.

When Elon Musk sold his stake in Zip2, much of the money went into a new high risk ventures that subsequently got merged into Paypal. In turn, when Paypal was sold, much of the money went to high risk ideas such as SpaceX and late by way of a Series A investment into Tesla (among other companies).

Of course, not all risks pay off which is why it’s still called a High Risk Venture. But unlike private markets where the risk is all or none with little or no liquidity, secondary markets offers the best of both worlds.

As Investment Advisers and Agents start crowding around the new Millionaires and Billionaires created by the Flipkart sale offering safe investments (with a nice commission inbuilt for themselves), I do hope most remember that they are there because of the risks they took, not because they turned out to play it safe.

Pilgrimage to Omaha – The Annual Confab

Going on a pilgrimage is as old as Religion. Men and Women have been for thousands of years going to the holy places of their religion in the search for peace, knowledge and enlightenment.

In the good old days before you could magically move from one corner of the earth to another in a matter of hours thanks to advances in transportation technology, this was a gruelling, time consuming and risky venture.

People didn’t go to pilgrimage of the holiest places as part of a tour package when young but as a search for something higher after having accomplished everything they desired to accomplish for there was no knowing if they would come back to the life they had.

For many years now, going to Omaha, the place of the Annual General Meeting of Berkshire Hathway has become a pilgrimage for those investors who emphasise on following the path laid down by the sage of Omaha as Warren Buffett is called.

From High Networth Individuals to Fund Managers to even Fund Distributors are now transported half way across the earth to be part of this big bash. While the meeting in itself is now web broadcasted, there is no dearth of those who wish to be part of the event physically.

While it’s one thing to believe in his principles, it’s quite another to follow and hence it’s not really surprising to see very few if any actually follow the path he walked upon.

Buffett Rule: “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

The thought process here is that you are not buying a ticker symbol but a business that you understand and once you buy, there should be no regrets, at least in the immediate months and years due to market / earnings volatility.

I was looking at a fund from the same fund house that took their top selling distributors to Omaha and stumbled upon something interesting. Of the top 10 stocks they were invested into 3 years back, 6 (60% of the top 10) aren’t even in the complete portfolio of today.

While 10 years maybe too long a period to hold stocks given the changing ecosystem, I was surprised to see such wide changes by a fund management house that swears by Buffett.

On the other hand, I think they were right – all six stocks are either in Industries that are for a long period of weak earnings or worse. Finally, investors reward fund houses with more assets only when performance is great, talk itself is cheap.

In his 2016 Annual Report, he wrote and I quote,

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients,”

Yet, Fund Managers regardless of size of their Assets under Management try to charge the maximum that can be charged to their investors. Warren himself has gone on record to recommend investing in low cost options such as Vanguard ETF. In India though, such views are anathema.

Warren Buffett himself gets just $100,000 as Salary for being the CEO and CIO of a company that on market is worth 488 Billion Dollars. Don’t even bother to calculate the decimal point that is the fund manager fees.

One of the reasons for higher charges being accepted has been the fact that unlike the United States where the large majority of mutual funds never beat the market consistently, here fund managers have accomplished the impossible.

The new SEBI regulations on Categorization and Rationalization of Mutual Fund Schemes shall have a large impact on fund returns and the alpha they can generate going into the future.

Fund Managers can deliver Alpha in two ways. One is to differentiate in weights compared to the Index they follow. For example, assume a Stock ABC which has a weight of 10% in the Index while having a weight of just 1% in the fund. If the stock drops 10%, the impact on the fund is much lower than it’s on the index thus providing Investors with an Alpha.

The risk though is that if the stock moves up 10%, the fund under-performs the Index in a big way. This is a risk that most fund managers take by lightening their holdings in stocks they feel will no deliver while being overweight on stocks that they believe has a better future.

A second way to generate Alpha is by investing in stocks outside the Index. Since the stock is not part of the Index, if the stock delivers returns above that of the Index, the fund manager feels rewarded for taking the risk of being underweight Index stocks while being overweight other stocks.

SEBI’s recent circular now limits the ability of the fund manager to pick up stocks from outside the Market Cap the fund is categorized currently. While the Alpha picking ability of fund managers were already on the way down, this should accelerate since there is little you can do to differentiate yourself from your peers or the Index.

Yet, fund managers expect that paying 2.5% for that is “sahi hai”.

When Warren Buffett started to manage other people’s money, he had an interesting way of how he will be compensated for his efforts.

Firstly, he collected no Management Fee. While we are seeing a few funds today that are following the same strategy, remember he did this in 1956.

Second, every partner would be paid 4% interest on his capital (remember, capital which could be growing or falling). Returns post that 4% were then split 50:50 between Buffett and the Partnership Investors.

In 1958, he modified it to make himself liable to pay 25% of the losses and the 4% interest if he generated a negative return on the investment during the year.

While I am no fan of Warren Buffett, its things like this that make you wonder how far ahead he was in being fair and equal when it came to outside funds. They don’t seem to make men like him anymore.

Don’t walk behind me; I may not lead.

Don’t walk in front of me; I may not follow.

Just walk beside me and be my friend.

– Albert Camus

Source on his Fees: What was the fee structure of Warren Buffett’s first investment partnership started in 1956?

Running out of Options and Money

Aircel was recently in the news for being the latest telecom operator to go under as it filed for Bankruptcy with 15,500 Crores of Debt on its books. In its statement, the company said it was forced to file for Bankruptcy owing to intense competition following the disruptive entry of a new player, legal and regulatory challenges, high level of unsustainable debt and increased losses.

“Unsustainable Debt” is another word for Leverage. While the business model may have changed over time, what ultimately caused its demise was that its Leverage ratio was just too high. In stock market parlance, that would be – the broker made the margin call and I had no more money to invest.

Aircel was a Private company and hence we may not know the exact leverage ratio, but we know of Leverage ratios of a host of companies that are either close to or already bankrupt.

As of 31^st March 2017, Bhushan Steel where NCLT is preparing to auction the company to the highest bidder had a Negative Equity + Reserves and a Large Debt. Interest pay out was 35% of Sales – Sales. Not of Profits.

JP Associates situation wasn’t so bad, but with Leverage of 10x, there is no way the company could have continued to operate without huge infusion into capital.

There are literally hundreds and thousands of companies that are doomed to survive thanks to their overwhelming debt – most of them being small private companies fly under the public radar and are noticed only as a line item when the Bank decides to write off the debt.

RBI said that total Non Performing Assets hit 7.34 Lakh Crore at the end of September 2017. Lest you get confused with the repetition of Lakh and Crore, the NPA figure RBI put out is Rs.73,39,74,00,00,000

To put that number into context, that number is bigger than the Annual Budget Deficit of the Union government. Yes, Banks have lost more money (or are close to losing since not everything is a 100% loss or has been totally written off) than the additional expenditure government thinks it will spend over its Income.

Traders in many ways are like the companies that raised debt hoping for a glorious future where one can drink a Beer and trade for a living, living off the beaches of Goa.

Trading, like every other business is capital intensive. You need a certain amount of capital to be able to try and live off the earnings. Unfortunately, unlike any other business, a trader doesn’t get bank loans.

This means that a trader has to come up with enough money on his own to be able to trade the position size he wants which in-turn hopefully will like a ATM machine can be used to withdraw money anytime there is a need.

Traders and our Dreams.

Dreaming is one, but how do you find enough capital to make it a worthwhile strategy to execute. I have in the past written about how much a trader should have as his capital before he even places a single trade and that number isn’t small.

Thanks to the Brokerage, Taxes and what not, Trading is a Negative Sum Game. What his means is that not all the losses of the losers go to the Winners. Brokerage and Government fees mean that winners do not get all that is lost by the losing party.

Yet, the appeal of trading using Leverage just doesn’t go away. While in the earlier era, we had Badla system where a financier would finance your positions for a price, now we have Derivatives where with a small margin you can get a large exposure – large enough to either make you or break up depending upon which side you end up when the move happens.

Leverage kills – be you an Industrialist or a small time Trader – longer you are holding the ball, higher the risk that someday will be your last day.

Selling options (with the hope that they will expire worthless) is a strategy followed by many. After all, if a large (60% to 90 %, depending on source of data) of all options expire, the seller is always having a better hand compared to the buyer is a argument I have heard often.

In his latest Annual Report, Warren Buffett makes an interesting point about avoiding leverage or rather over-leverage.

Charlie and I never will operate Berkshire in a manner that depends on the kindness of strangers – or even that of friends – Warren Buffett

I was reminded of the above quote when someone posted a tweet which read

There are two enemies for Option seller:

Huge Gap up or Gap down.
Huge two way move.

Both happened today and lost 6 months profit.

End of day to End of day, the day when the above tweet was made, markets didn’t crash by any significant measure. Yes, it was a volatile day, but by the end of the day, markets were slightly lower but not one that was of any unusual concern.

And yet, the person above had lost 6 months of his profits. 6 months for one day’s move. This guy is not an average investor or trader. His Bio reads and I quote “stock market expert with more 25 years’ experience in the industry.”

Long Term Capital Management was a firm founded by those day’s who and who in the finance industry and the results of the first four years showed the level of calibre as they delivered outstanding returns with very little volatility.

And yet, one bad stroke of luck and voila – the Federal Reserve had to step in to bail them out with every investor invested in the fund losing out on 100% of capital.

The attraction of trading options / futures is tough to deny. Where else do you hear about doubling capital in a month, generating good cash flow month after month among other stories.

But not everyone is suited to it and even those who think they are suited, there comes a time when they realize that they weren’t really ready. But then, that realization more often than not is realized after the Horse has bolted the Stable.

It’s one thing to be a rookie and get killed and quite another to think of one as a Ring Master and yet get killed by the very Lion one assumed had been tamed. Markets are wild; there is no taming it one way or the other. If you are exposed to risks that you aren’t prepared for, getting killed is a very real possibility.

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