Being Early is No Better than Being Wrong

Castlight Health (CSLT) surged from $10.06 to$15.6 in just four days after Seeking Alpha wrote a pretty damning hit piece on it.

Here’s what’s really stupid. I thought I would bet against at what the time was a 43% gain, but I was early. It became a 60% gain and now I have a $300 loss on my P&L -even after it went up 45%, as if that wasn’t enough. I only bought 9 deep in the money puts and went long 400 shares. I went long shares to cancel out some of the delta from the puts after the trade began to turn against me. Had I just shorted the common stock the day of the Seeking Alpha article I would have lost all my money after getting a margin call. Had I bought puts I would have lost maybe 20-40% depending on the strike and expiration, but it still would have been pretty bad. I’m still bearish on Castlight Health because the fundamentals look poor and the price is way over-extended, but timing is everything. Robert Shiller says bubbles can be predicted; profiting off them is a test of timing and psychology- not being too early and not getting scared and closing the trade too soon. For this very reason, only a tiny, tiny number of people made money shorting grossly overvalued tech stocks at the turn of the century and the same goes for the crash of 2008. Everyone else either missed it or got stopped out because they were too early. But on the other hand, being too late won’t help either. In the second law of thermodynamics no energy can be extracted from a system with maximum entropy. In the stock market, certainty is analogous to entropy in physics. Once it’s incontrovertible a company is insolvent (i.e. cancellation of the common shares) or acquired (i.e. common shares accreted by suitor) the market as a real-time mechanism for gauging uncertainty ceases to exist and hence no profits can be made. Entropy can also be manifested in the volatility, with higher entropy corresponding to lower volatility. Thus, making money in the stock market boils down to betting on an orderly system becoming disorderly or a disorderly system becoming orderly. What do you think will make an option trader more money? Betting$1000 on Facebook falling 4% in one day or Walmart falling 4% in one day? The later because it’s a much less expected event. The more stable people think something is, the greater the returns can be realized when it becomes unstable. A failed merger, for example, can net option speculators returns of over 100x overnight because it’s very rare occurrence. Buying put options on Bank of America in 2007 was very profitable because at the time it was inconceivable the bank could fail. So why didn’t people do this? A few did, but most were oblivious. But for more technical reasons, option traders typically lose money if nothing happens; enough bets and you will lose all your money should the stock not fall or rise enough, depending on your strike price and time until expiration.

Profitable strategies will be discussed in later blog posts.