When I launched Phase 3 in March, I put 20% of my book into software while the market was busy explaining why AI would destroy it. In last week’s update, the basket was up 47%. I added to it last week on the pullback as I still think there is more to come.

I could spend today talking about how well that trade has worked, but there isn’t much point. The more interesting development here is that I am now prepared to buy a name in the part of the AI trade that I spent most of the summer avoiding.

I had very little appetite for adding to semis and memory. Positioning had not cleared up enough to my liking, and the bar for earnings was less forgiving than it was for software, as I said at the time. Since then, the unwind has left one of the companies supplying the AI buildout on a much lower multiple while earnings estimates have continued to rise - so it deserves another look, particularly when the reasons I had for staying away were price and positioning in the first place.

You could count the larger trades I placed over the summer on one hand. I am happy sitting on positions when I still like what I own. I still think SPX trades with an 8 in front of it by year-end, but getting that right will only take you so far considering the dispersion we have experienced basically all of this year. From Memorial Day to Labor Day, SPX gained 4%, equal-weight S&P gained 7%, and momentum factors got taken to the cleaners. Goldman’s TMT pair was cut in half from its June high and recorded its worst two months on record. So plenty of people could have been right on the index but had a miserable summer in the names they owned. Meanwhile, you had a huge vol compression with VIX closing last week just above its YTD lows, and VXSMH has reset to ~36 from the mid-60s in July. Protection deserves a fresh look at these levels. With a good chunk of unrealised gains, I want to be able to add to something without leaving all of the gains exposed to a reversal. A SPX put will not necessarily do that, particularly if it keeps grinding higher while my names give back some of their gains.

Finally got short EUR/JPY alongside Scott Bessent last week, I can’t say I imagined to be up a few % so quickly, but here we are.

Earnings are why I remain bullish. We’ve seen the forward P/E decline to 19.5x from 22x at the beginning of the year. So, despite market progress, you’ve simultaneously seen multiples compress, and analysts continue to raise estimates.

I discussed this back in August when talking about the hyperscalers. A higher capex bill is much easier to live with when demand and revenue are rising with it. It gets considerably more difficult when the company spends more and leaves you guessing about what comes back.

The forecasts could be wrong, of course. Rising estimates do not settle the arguments over margins or the eventual return on all this investment these companies are making. But they do make it difficult for me to build a bearish view at present simply because September has arrived, and oh boy, have we all heard about September seasonality. Yes, I am aware of the seasonality chart; I see it every year. Please don’t mention it in the comments, I am tired of it.

Touching base on positioning after last week. I obviously described it as getting clean across the board. But I wanted to touch base on a few things… Fundamental l/s funds in Goldman’s data has net exposure at the 15th %ile over the past year, which is clean. However, if you look at a five-year lookback on gross, it’s sitting at the 82nd %ile. A low net number therefore does not necessarily mean that there is very little leverage left to unwind, but when you put things on a five-year lookback, that five-year comparison also includes 2022. So I do stick by my comments that positioning is clean; just take note that some measures aren’t.

The Nasdaq futures data is more awkward for the underowned argument. Between the start of August and the 1st of September, non-dealers bought ~$50B, hedge funds accounted for ~$37B, with ~39B of short covering. There was some fresh buying, but a great deal of the demand has come from cover bid. By the beginning of this month, Goldman had net Nasdaq positioning at the 92nd %ile over two years.

All of this indicates to me that index-level positioning is at a healthy level, and for any further upside, you need the earnings to arrive and investors to choose to add exposure instead of de-netting.

Some of the recent winners may already have priced in a good chunk of the improvement.

The main macro problem here is the long end. Yet equities have been able to tolerate higher yields as growth and earnings have been strong enough to compensate. An energy-led inflation shock would be a less comfortable combination since it would put pressure on costs and leave less room for central banks to ease, but that remains a hypothetical at this juncture. I am more interested in whether this happens rather than trying to extract another market forecast from every sentence of a Fed speaker.

So overall, I remain bullish, but the case for adding size has to be made at the level of the position. Three trades today: the first is a new AI-focused long, the second a hedge, and the third is the EUR/JPY short, which has already moved too far for me to finish sizing for now.

I barely traded over summer, that is about to change.

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I have taken a few weeks off from writing. August is up there with Christmas time when it comes to the noise to signal ratio, while there has been plenty of action in names I own - index has pretty much done nothing since the first week of August. That should now change with Jackson Hole having happened, which is my green flag that summer is coming to an end. I have never seen much point in creating a market view just because another post is due on here. I am not here to give people their dopamine fix, sometimes there is nothing useful to add and the correct trade is simply to do nothing but sit on your hands. Yes, in a world full of grift, there will always be someone willing to fill the silence with another urgent chart or trade. Pretending there is always something to do may well be great for engagement, but I am not so sure it is for portfolio management.

I don’t plan on writing a post about Jackson Hole, having watched it, I still think most of it was noise, as I did before the event. He was hawkish, trying to make out that September will be a “live” meeting (rates will stay where they are) with a smack in the face for gold and ten year +4bps, with short term rates moving even more aggressively. The speech will be forgotten come the next NFP print, so not a lot more to comment on.

What has changed, and is worth discussing, is my Phase 3 basket. Back in March I launched this basket. I’ve written about it plenty of times but for those that don’t know… it’s a 15 name software basket which at the time was probably the most hated area of the market - AI would destroy software seats, make code abundant and leave the application layer looking like a bunch of expensive subscription dinosaurs. When I last wrote about the basket, it was up 36% with 14/15 names higher. As of yesterday’s close, it is now up 47% since inception. It’s been a great trade, and was published and fully sized when consensus was calling for the death of software but the performance is not the reason I am writing. I am writing about it again because the evidence is getting stronger and the language around software has been changing quickly. When I put the basket on the opportunity was price, today prices are higher but so is the probability that the thesis is right. I have not increased the position from its original 20% allocation yet, but I am seriously considering it and that’s what I will write a lot on in this post.

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Another interesting week with SPX closing at 7758, leaving it with 242 handles from 8000 and over 400 above the low, where I thought the momentum unwind still had more work to do.

I know I mentioned this in my last post, but for those who missed it, I basically gave too much weight to 7200 during the dip, should’ve monetised more of the hedges on the way down, and the market chose the route I had assigned less probability to. I can spend another page explaining how I remained long throughout, but I suspect most people reading this understand the difference between owning hedges and running a short book. We live, and we learn…

I think the most interesting thing since my last post is that this has not been a clean return to the normal AI trade. NDX gained just over 5% last week, SPX made another ATH, and the VIX ended the week with a 14 handle, but some of the largest moves came from software and Mag7 names squeezing higher while a collection of shiny AI names traded lower. You can see the same thing in momentum. L/S momentum factors are blowing up because software has ripped while semis have been hit. Maybe we are seeing a reversal in momentum - the low momentum switching to high momentum and vice versa…

Anyway, the new positioning data is more useful than discussing the index itself. In my last post, I said I wanted to know whether the buying was from cover bid and call demand, and whether it was moving into proper long buying. I now have enough new data to start answering that question.

It also gives me a good excuse to revisit my most recent basket - Phase 3 AI. This is a basket with 15 names that I shared back in March, which is now up 36% with 14 of 15 names higher.

Lord Fed's Gazette

What If Everyone Is Wrong About Software?

If AI is going to replace software, why hasn’t it done it already…

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6 months ago · 249 likes · 29 comments · Lord Fed

I have not written about it much on here since inception, which is surprising given its return and contribution to my NAV. The first move came as the market stopped treating software as an obvious AI casualty. Two positions have doubled, and another is up over 90%, but interestingly, the thing I bought the basket for has barely started showing up in numbers, which leaves me thinking we might be just at the beginning of this trade.

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With the S&P trading at 7,800, it has managed to make me look right and wrong at the same time.

Some time ago, I said that SPX could trade to 8,000 this summer. I also said that the destination was considerably easier to forecast than the path, and that a 5-10% air pocket could arrive before or after it. Just before the market sold off to the low 7300s, I chose the bearish path and made 7,200 my base case before 8,000.

The market has rallied just shy of 500 points since Wednesday’s low and is now 200 handles from the 8K handle. I am not going to hide from the fact that I gave too much weight to the downside during the dip. But equally, I am not going to pretend that the original 8,000 forecast no longer counts merely because I bought protection against the journey. Unfortunately, the market chose the road I assigned less probability to. I got bullish on the 30th March this year, after a small technical indicator flashed bright and have remained bullish ever since… At some point I was bound to misread one bend in the road.

The more important point is that I did not turn uncertainty over how we got to 8k into a huge short position. I remained long throughout the sell-off and the entire rally. I cut AMZN after earnings for a gain, which I explain later in the post, but have kept my Phase3 basket at a 20% weight, ORCL at 10%, META at 9% and MSFT at 7%. The puts have been a small PnL drag as the market reversed, but my book has continued participating; if anything, it’s outperformed.

In my last post I wrote:

“If SPX goes straight to 8,000 as previously forecasted, the hedge costs me 1%, and the rest of the book should make money. Fine.”

The part I got wrong was how much work the first puke had already done. I focused on the fact that longer-term leverage and momentum exposure remained elevated and concluded that the initial sell-off still had considerably more work to do. The positioning reset had already become enormous. One prime book recorded the second largest de-grossing in its available decade of data. Fundamental managers had taken gross towards one-year lows, and some momentum factors were down 40-50% from the highs.

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I am back after a short break from writing, spending some quality time with my family in Mallorca.

A fortnight ago I wrote about how SPX had remained calm because every ugly move underneath it came with an offset somewhere else. A day after that post, with SPX trading at 7550, I bought puts, as I came to the realisation that those “offsets” wouldn’t work forever. SPX closed at 7,412 on Friday, so those puts have at least started doing something. I refuse to get carried away, as we are still just under 2% below where I bought the hedge and the move has not been the air pocket that I described. I am not going to declare victory every time the market has one bad Thursday. If I wanted to do that, I would have launched a bear Substack and predicted nine of the last two corrections.

I think what happened on Thursday and Friday was more useful than another ordinary red day. I’d say that the market briefly showed us both the trigger for a considerably larger move and the off-switch that stopped it becoming one.

Alphabet reported good operating numbers, and demand was apparently strong enough for the company to raise 2026 capex guidance again to $195-205B. FCF nevertheless fell to -5.9B for the quarter, and the stock fell 7%. Alongside this move, you had brent pushing $100, 10yr >4.7%, while the Nasdaq fell 2%.

Then Friday arrived; reports of possible US/Iran talks knocked Brent back down, yields eased, and SPX finished flat. Nasdaq closed down 1% so the market has yet to rediscover its love for AI… it was more that macro pressures eased.

Anyway, these two days are probably the most important thing to have happened all week.

I think it was around a month ago that I wrote on X that index had developed an almost built-in AI hedge. If hyperscalers increased capex, the companies receiving the money rallied because the spending became their revenue. If the hyperscalers were to say they were spending less, their own stock rallied because lower spending improved FCF and left more room for buybacks. One side could get hurt, but the other normally caught enough of the money to stop the index falling very far.

That arrangement has made SPX remarkably difficult to send down. It is also one of the reasons all the violence I described two weeks ago kept disappearing at index level.

Alphabet was the first time the index cared, spending went up, the payer was punished and the wider group of recipients failed to rally enough to replace it. Some parts of memory may have held up, but the old response of blindly buying everything that might receive a dollar of hyperscaler capex was nowhere near as clean. The largest index weights fell, and the supposed hedge on the other side was too narrow to hold the whole thing upright. (I should probably note that Alphabet was not the first warning across AI. It was the first one large enough to matter at index level. During the previous fortnight, ASML, TSM, TXN, MXL, INTC and BE Semi had all managed to trade lower despite beats or guidance raises.)

Friday bought the market some time, but did not fix anything. Broader tech positioning is cleaner, but the conviction and crowding are still concentrated in semis and hardware, while the knife catching has not disappeared. Even the support on Friday looked more defensive than bullish - AAPL outperformed nearly 5%, and names like T had their best week relative to the market in decades…

My read here is that Thursday was a warning rather than a flush itself. The puts have more work to do.

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Yesterday’s post was titled A Violent Market Pretending to Be Calm for a reason. SPX has managed to sit near the highs with VIX in the teens while the average stock moves like a madman, and entire factors suffer corrections that would normally come with a much uglier index. It has got away with it because the pain has happened in different places on different days. Semis rally while software gets smashed, Mag7 recovers while momentum unwinds elsewhere, and the opposing moves cancel each other out by the closing bell. That works until it doesn’t.

The bit that worries me now is what happens if all these supposedly different trades start moving together. Implied correlation is sitting around historic lows, so the options market is still pricing the offsets to continue. If correlation rises, index vol catches up to what has already been happening underneath it, and everyone discovers at roughly the same time that their book was less diversified than they thought. Add summer liquidity, high gross, levered ETFs and systematic sellers to that, and a fairly ordinary first move can turn into something much nastier before the fundamental explanation has even been agreed upon.

I don’t mean another 1-2% wobble that gets bought before lunch. I think there is a proper 5-10% air pocket lurking somewhere in this summer, and I have now started paying for protection against it. Not a token VIX call or a put so far out of the money that it only works if the world ends. I want something that begins working early enough to be useful and leaves me with cash if the index gets anywhere near 7,000.

Here is exactly what I have done and how I intend to manage it.

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After a week of very limited phone reception and 2 Mbps internet in a remote beach house in Wales, I am back! I average around 10 hours a day of screen time on my phone, so the break was quite nice and probably good for the soul.

Two weeks ago, with SPX sitting at 7,350, I put a 7,700 July target before the paywall and said an August print above it was not off the table. SPX closed Friday at 7,575, so we are now 125 handles away from the original target and close enough that pretending 7,700 is still the interesting part of the call feels a little pointless.

It would obviously be easy to spend 500 words celebrating recent calls and another 2,000 explaining why the final 125 handles should trade. But I don’t think you need me for that. The more interesting question is surely what happens after 7,700, because while the index has quietly marched towards it, the market underneath has been screaming.

Many momentum factors have fallen more than 20 percentage points. The mainstream momentum ETF fell 11% peak to trough, and SOX went from trading around 80% above its 200-day moving average to a much more normal distance - 36% at the bottom of the recent dip and around 46% now. Mag7 suffered a roughly 15% correction (the below post was where I said to buy the Mag7 dip and explained my reasoning).

Anyway, continuing with my list of bizarre things that have happened despite SPX trading where it is… the shiny space, drones, quantum, non-profitable tech all got smashed. Software is split into two completely different markets all while SPX sits within touching distance of another all-time high.

While most wait for some kind of correction in index, I think the most important question here is whether the violence underneath the market has already removed enough excess to extend the rally or whether it is eventually going to escape into the index itself.

VIX with a 16 handle suggests a fairly orderly index. Single stock vol, positioning and now parts of the credit market say something very different. So today’s post is about which signal I trust, what happens after 7,700 and why I think the next meaningful move will be considerably larger (and probably less straightforward) than index is currently pricing.

My focus this summer now moves onto that 8,000 touch.

Before you all assume that is me expecting another 425 handles in a straight line, I don’t. In fact, I’d be surprised if we make it through the rest of summer without a proper 5-10% air pocket somewhere along the way. I have considerably more conviction that we see both 8,000 and a violent drawdown than I do in which one comes first. I am bullish on the destination but increasingly suspicious of the path.

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Brazil went out to Norway, which tells you everything about what this summer does to crowded consensus longs. Dare I say, as an Englishman, that England is another overcrowded long? For the Belgium USA game… it will all depend on which Belgium turns up. If it's the one from the first 80 minutes against Senegal, the USA wins 3-0. If it's the final 10 minutes version, the US are in for a tough game. Spain Portugal game… I just don't think the young Spain team have the experience despite being incredibly talented. Not a strong stance, but I will take Portugal to qualify.

Speaking of which… last week I said buy Mag7, and it worked out fairly well, closing out with their first green week since late May where the cohort sold off just shy of 15% over four weeks. Mag7 closed up roughly 5% on the week vs SPX +1.7% and NDX +0.7%, which is not exactly a marginal relative move. That is the kind of week that makes everyone who “prudently reduced exposure” start checking their charts at dinner and pretending they always planned to buy them back lower. I am not moving the goalposts either, July SPX target stays the same at 7,700, and the August overshoot I floated last week is still on the table… positioning hasn’t given me a reason to shelve it.

Quick recap for anyone who missed Vol. 12 (The Mag7 ATM Is Running Out of Cash), because I'm not going to re-argue the whole thing. The call was never Mag7 is cheap. The call was that Mag7 had become the market's ATM, the most liquid, profitable, highest-quality companies on earth being sold to fund every shinier trade in the tape, and that all of that selling had created room. Anyway… this week is about what's changed and how I’d trade the next leg.

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I’ve written a lot on here about the down-cycle: drawdowns, ruts, fear, revenge, the whole catalogue of ways a losing stretch can rip you apart. And it should get the attention, because losing hurts. But if I’m being honest about where I’ve done the most damage to my own book over a decade of managing real money, it wasn’t in the holes. A lot of the time it was at the highs. The worst trades of my career didn’t come when I was scared and down. They came when I was up, loose, and absolutely certain I’d figured it all out.

This is the post nobody writes, because it doesn’t feel like it needs writing. When you’re winning, the last thing you want is some bloke telling you to be careful. But that’s probably the moment you need to hear it, and exactly the moment you won’t. So let’s talk about the thing that actually ends most good years: not the losing, but the winning that came right before it.

A losing streak comes with built-in brakes. The pain itself is a brake, as is loss aversion. Fear slows your hand, makes you cut size, hesitate, and eventually makes you step away from the screen entirely. Your nervous system is screaming at you to stop, and your account balance is physically shrinking, which caps how much more damage you can do. A drawdown, left alone, tends to decelerate. The market and your own fear conspire to apply the handbrake.

A winning streak has none of that. There is no internal mechanism that fires when you've been right too many times in a row. Euphoria does not self-correct. Confidence does not throttle itself. The dopamine doesn't tap you on the shoulder at the right moment and say that's enough now. You just accelerate, and it feels fantastic the entire way, right up until the wall. You are speeding up while smiling.

That's why being up is more dangerous than being down and why I decided to write this post. Down, the market is fighting you, and so are your own emotions, and between them, they slow you down. On the up, everything is pushing you to go faster. Your P&L, your mood, your brain chemistry, you name it. And there's nothing in the system telling you to ease off. The handbrake during a winning streak has to be installed manually. It is the only one you have to build yourself, and almost nobody does.

If you keep a journal, and I’ve banged on enough about why you should, go back and look at the trade you put on immediately after your single best trade of the year.

I’d put money on it being one of your worst.

There’s a window that opens right after a big win, and it’s lethal. You’ve just been paid, handsomely, for being right. The afterglow is real, and it’s chemical. I went deep on dopamine in Mastering Your Mind, so I won’t repeat it, but the short version is that your brain has just been flooded with reward, and it wants to do that again immediately. So you go looking for the next trade. Not because the setup is there. Because the feeling is there, and you want more of it.

And in that window, your guard is down in three specific ways. Your sizing is loose because the last big bet worked, and your reference point for “normal” has just been dragged upward. Your standards are loose because you feel like you can’t miss. And your process is loose, because winning makes the checklist feel like a formality. Why run the full pre-trade routine when you’re clearly seeing the ball this well?

That’s the post-win trade. Bigger than it should be, on a worse idea than usual, with half the diligence. It is the single most reliable way I know to give back a chunk of a good run, and I’ve done it more times than I’d like to admit, as have many. The cruel part is that the better the win, the worse the follow-up tends to be, because the size of the win is exactly what determines how loose you’ve gone.

The rule I’ve landed on is simple and I try to treat it as sacred, which is that the trade after a big win gets less size, not more, and gets the full checklist, not a waiver. If anything, the moment you most feel entitled to press is the moment to do the complete opposite.

There’s a phrase that floats around when people are up, and I suggest you delete it from your vocabulary - playing with the house’s money.

You’ll hear it, you’ll think it. “I’m up 30% on the year, so I can afford to swing a bit.” It is one of the most expensive sentences in trading, and it’s a textbook case of what behavioural folks call mental accounting. The money in your account is your money. It doesn’t matter whether it arrived last week or last year. The moment it’s in your book, it’s your capital, and treating last month’s gains as casino chips is precisely how you hand them back.

The market doesn’t know nor care that you’re up. There’s no asterisk on a loss that says it doesn’t count, was made with profits. A 10% hit from a high is a 10% hit, and it’s coming out of your money. The instant you start mentally ring-fencing some portion of your equity as expendable house chips, you’ve given yourself permission to be reckless with it. And you will be.

I keep one number in my head and it’s the only one that matters: the account, as it is, today. Not the high. Not where it was. What I’m actually holding, right now, which I am responsible for protecting. There is no house. When it comes to markets, we are all the house, and the house’s whole edge is that it never gets emotional about a winning night.

I’d say confidently that the silent killer is the sizing creep. Nobody wakes up and consciously decides to double their risk. That’s not how it happens. It happens by creep.

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This is the thing I want you to really think about, because it’s the mechanism that does the most quiet damage during a good run. I wrote in the Size Matters post that size is more important than entry, and that too big is defined by your own behaviour rather than a percentage. But there’s a version of “too big” that’s even sneakier than the one I described there, and it only shows up when you’re winning.

During a streak, your size ratchets up imperceptibly. You add a little because the last one worked. Your new “normal” is slightly bigger than your old normal, and it felt fine, so the next normal is bigger again. Each individual step is tiny, and each one was vindicated by a win, so there’s no alarm. No single decision ever felt reckless. But string ten of those together, and your “core” size is now something you’d have called aggressive two months ago, and you never once made the conscious choice to get there. The streak made it for you.

Then the regime shifts, or vol expands, or one trade simply doesn’t work, and you discover you’re carrying three times the risk you think you are, with none of the emotional preparation that comes from deciding to be that big.

The fix is mechanical. Anchor to a fixed base size and recompute it from your rules, not from your inflated equity. Every so often during a good run, ask yourself flat out: “Is my current working size the one I’d have chosen on a cold morning with no recent wins behind me?” If the honest answer is no, you’ve got creep, and you trim back to your normal size, whether it stings or not.

I think another dangerous thing about winning streaks is that they have the ability to rewrite who you think you are. When you’re winning, you start to believe the winning is all skill, which is normal. It’s a very natural and very human error. You did your analysis, put the trades on, and they worked, so clearly it’s all you. What gets quietly written out of the equation is, one, the regime, and two, luck. Most strong runs tend to happen because the market handed you an environment that suited your style. The trend was clean, vol behaved, and your bread and butter set-up was printing because these conditions were ripe for it. Sure, you were good, but you were also fed.

The trap here is that the streak convinces you that the regime is permanent. It convinces you that the way the market is behaving right now is normal and just the way markets are. And that your recent results are the baseline you should expect going forward. Recency bias is dangerous, and when the regime finally turns (oh, and it always does) you keep running the playbook that worked in the old regime straight into the new one, sizing your positions up because it’s been working right up until it very much isn’t.

I have lived this one properly. I had a stretch a while back where a particular kind of environment suited me down to the ground, and for a good while, I couldn’t put a foot wrong. By the end of it, I’d half convinced myself I’d cracked the code, but what I had actually done was get very good at trading that specific regime, and I mistook the regime’s gift for my own genius. And of course, it finally flipped and caught me out, giving back a good chunk before I was willing to admit the world had changed, and I hadn’t. The lesson here for me was that I’d stopped being able to tell the difference between my edge and my luck, and a streak is precisely the thing that erases that line.

When I wrote the Size Matters post, I wanted to give you the behavioural cues to look for when your size is wrong. Here’s the equivalent checklist for when you’re getting high on your own supply.

1. You are checking your PnL because it’s fun

   • When you’re down you check out of fear

   • When you’re up you check for the dopamine hit

     • Both mean the number has way too much power over you

2. You’re telling people - be that your partner, colleague or anyone that’ll listen

3. You’ve stopped journaling

4. You’re bored with your normal setups and find yourself reaching for spicier trades just for the stimulation

5. Lifestyle creep

6. You’ve rounded your size up

If three or more are true, you’re at the most fragile point of the cycle, and the smart move is to de-risk into your own strength.

In my Drawdown Psychology post, I tried to cover how a drawdown can ruin your life outside the screen - losing sleep, irritability, and so forth. What nobody will tell you is that a winning streak can do its own kind of damage but because you feel good, you never see it as a problem.

You actually sleep worse during a great run, not better, because you’re wired and excited and your brain won’t switch off thinking about the next idea. You start spending gains you haven’t realised. Your ego inflates, and the people around you notice before you do. And the higher the high, the harder the comedown when it’s over because you’ve let your sense of self get tangled up in the equity curve.

So, as a follow-up to my Drawdown Psychology post, protect your life from trading in both directions. A great month shouldn’t turn you into a different person any more than a terrible one should. If a win is making you sleep badly and spend stupidly and quite frankly act like a prat, the win is also costing you. You just can’t feel it yet.

So what to do if you’re winning… A good start is to take some off, mechanically. As I said in Size Matters, some of the most successful guys I know will systematically trim into strength so that when the inevitable reversal comes, they’re already smaller. Reduce size after a run, not just after a loss. Cutting when you feel invincible is the hardest thing to do, yet the most valuable and one of the things that separates people who keep their gains from those who round-trip them.

Another thing to do is to keep journaling the winners. For those who journal, it’s common to stop writing trades down because winners feel self-explanatory when they’re not. If you only autopsy losers, you bank every bad habit that got rewarded by luck, and you’ll repeat it at size next time. So write down your gains, and be honest about which winners came from good process and which were just coin flips that landed your way.

In Size Matters, I made the point that the penalty for overestimating your edge is roughly twice as severe as the penalty for underestimating it. Here’s why that’s the whole ballgame for this post: a winning streak’s single most reliable effect is to make you overestimate your edge. You have seen your strategy win over and over again, so of course, you now think it’s better than it is. Which means a hot streak doesn’t just tempt you to bet more, it actively pushes you towards the exact error that the maths says is the expensive one.

The most rigorous sizing framework ever built and your own nervous system agree on the same advice, and it’s the same advice when you’re up as when you’re down - trade smaller than you think. You just don’t want to hear it when you’re winning.

That is it for me today… I’ll leave you with the line I’d tattoo on every trader who’s having the best month of their life - the drawdown you’re going to spend next quarter climbing out of is almost certainly being seeded right now, at the high, while you feel untouchable. Good runs don’t end because the market turns. They end because you changed.

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Happy trading,

Fed

Further reading on psychology…

SPX closed up on Friday at 7350 after the AI trade cooled a little. I’ll put my balls on the line before the paywall today, my July SPX target is 7,700. And if positioning stays the way it is, an August stupid-print above that is not off the table.

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Last week I entered two fresh SX5E positions at 1.2% weight (prem paid - not notional) as well as a single name in the US at 7% weight.

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As I sat and watched some boring World Cup games over the weekend, I found myself thinking less about football and more about how tired I was. Honestly, it was one of those weeks where the market did not move enough to justify the emotional energy it zapped from me, and from a lot of you, I am sure.

The kind of tired where you have spent most of the week staring at red candles, rates, AI headlines, hyperscaler funding debates, levered ETF noise, oil headlines, Warsh takes and, of course, SpaceX.

And here is the funny part. SPX opened the week around 7440, traded down to ~7240, and closed at 7431. The prior week’s close was 7383. So, depending on where you anchor yourself, the market was either basically flat from Monday morning or modestly up for the week. Nothing happened. And yet everyone I spoke to felt like they had just played 120 minutes a man down. Which is the bit I could not get away from. Index didn’t have a bad week; people did. The market closed higher on the week, and somehow everyone went into the weekend tired or hedged, half bullish/half-traumatised. It was a good example of the parts of bull markets people don’t like.

Every small dip starts to feel like the big one. Every bounce feels untrustworthy. Every high feels stretched, while every dip feels like a trap, which is the part of bull markets nobody likes admitting: they do not feel like bull markets while you are in them. They feel like a sequence of almost-tops. The bull case is always more annoying than the intelligent bear case that comes with numbers, charts and a little bit of moral superiority.

The bull case is much more annoying. It usually sounds something like “yes, I know, but it is still going higher.” Which nobody wants to hear because it sounds too simple, unserious and that you are ignoring the risks. But the whole job in markets is not to pretend risks do not exist, but to work out which are already priced in, which are being over-discounted and which the market is absorbing in real time.

As I said in last week’s Between the Lines post, SpaceX’s IPO was a big deal.

It was a test of positioning and liquidity. Following the IPO, I think the bull market is still very much alive, and 8K remains the summer target.

I think this week, specifically, the market can do something stupid.

A new all-time high this week is not a heroic call. We are sitting less than two percent from the highs, vol has backed off, the market has already absorbed a huge supply event, the broadening trade is starting to work under the surface, oil has become a macro release valve, and the main bearish arguments are now so well circulated that I am not sure who is left to be surprised by them. But let’s remember, markets do not exist to make you sound sensible at dinner. They exist to embarrass the largest number of people in the shortest amount of time.

So please let me be precise about what I am actually saying, because this is where most people get the number wrong. Where we are sentiment, positioning and level wise… 8K is not a consensus summer forecast. It is what happens if new highs trigger underweight panic and if/when hedges get monetised. It’s poetic with Mag7 acting like a funding short right now, as when that cohort rallies, it’ll really add oxygen to the fire. We also need Warsh to not deliberately tighten financial conditions at his first press conference. If liquidity is bad enough to make upside travel the way downside travelled last week, we could see a 200-handle green week this week.

The mistake people make with 8K is treating it like a valuation target. It is not. A valuation target is where you sit down calmly, plug in earnings, margins, multiples, the discount rate, the terminal AI productivity assumption and whatever other nonsense makes the spreadsheet look good. A market-structure target is what happens when the price gets above a level where people have to react. The first two percent is the index getting back to the highs. The next three percent is the people who thought they had time realising they do not. The final stretch is where the options market, levered ETFs, underweight managers, short-covering, systematic buyers, retail and the “I’ll buy the next dip” crowd all discover that the next dip was last week and they missed it (again). That is how these moves happen.

This is why I am less interested in the obvious bear case than I probably should be. I know it. Everyone knows it. If you don’t here is the list, bluntly put. AI is crowded, hyperscaler capex is absurd, software has a structural problem, equity supply is rising, token costs are falling, the IPO calendar creates funding needs, levered ETFs and options can turn a normal wobble into a stupid candle, Warsh could say the wrong thing, oil can rally, and rates can ruin the party. Fine. All of it is true, and none of it is new. If you’re bearish and somehow needed more material, I hope I have made your day!

Anyway, the market spent two weeks being forced to stare directly at every line of it, and the index still closed higher, which is the part the bears conveniently do not want to talk about, because it is more annoying than the bear case itself. The market has been handed so many reasons to break, and so far it has chosen to rotate, hedge, complain, de-gross, absorb supply and move on.

Positioning is the first reason.

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Fed

Last week I wrote that the underweight money would probably get stopped into the market, and that the easiest mistake was to confuse “stretched” with “sell”. And then Friday happened, and my weekend inbounds have all been similar questions…

Was Friday the top? Is this the start of something bigger? Was NFP the thing that finally mattered? And so forth.

I think the more important point to take away from Friday is that the AI trade did not die, it just changed category.

NFP caused Friday, I'm fairly sure of that. I sat there watching my PnL get worse by the minute, asking why, after that print, I hadn't bought 0DTE downside. I am still waiting on the answer. AVGO had already made the week feel heavy, and the GOOGL raise added a question nobody fancied dealing with on a Friday. So no, it wasn't a random red candle. The market was standing on one leg and got handed a rates shock, a soft print from a key AI name, and a wall of cost of AI headlines, all at once.

And yet even with all of that, it didn’t look like true panic. I think it was just a stress test where people managed risk via short-dated puts (QQQ+SPY had the highest put volume day in history). To put it bluntly, people haven’t dumped the whole AI trade from one Friday; they just hedged up and then cleared up any positions they didn’t fancy anymore.

To put this in simple terms - if people sell the thesis/narrative - you have a top. If people hedge the thesis/narrative, you just have a positioning problem.

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I think the thing that separates options traders from people who dabble in options and lose money is that options aren’t leveraged stocks. They’re completely different instruments that price direction, volatility, time, and path simultaneously. Most retail traders only think about one of those four. The market charges you for all four, every single time, whether you realise it or not. That gap between what you think you’re buying and what you’re actually buying is where most of the losses live.

Before we begin, the three most important (and probably generic) things I’d tell someone just starting out with options:

1. Your first job is not to make money. It’s to understand what you’re trading.

2. Cheap options are usually cheap for a reason.

3. Being right about direction is necessary, but nowhere near sufficient.

Most blow up because they ignore all three. They skip the understanding, buy the cheapest contracts on the chain, and they confuse a directional opinion with an edge. The irony is that options, used correctly, are the most precise and powerful tool in markets. Used incorrectly, and they’re just the fastest way to lose money with conviction.

Let’s call this post the foundation. No full-on Greeks lesson today (that’s Part 2), nor volatility surface mechanics or dealer positioning. There will also be no vanna or charm chatter throughout the whole series, nor will I write the post in emojis. This is just me explaining the core of what an option actually is, how they’re priced, what you’re really paying for when you buy a premium, the different styles and types you’ll encounter, and the structural mistakes most beginners make that are entirely avoidable once you understand the instrument properly.

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Same deal as the FX and Equities editions of this series, no textbook fluff. Just how it actually works.

And as always, proceed with coffee.

What An Option Actually Is

Let’s forget every convoluted definition you’ve ever read and strip it back.

An option is a contract where one party pays for a right and the other takes on an obligation in exchange for being paid. A right on one side, an obligation on the other, with a premium changing hands upfront. That’s literally it.

The buyer gets the right, and the seller takes the obligation. The buyer decides whether to act. The seller has no such choice. If the buyer wants to use their right, the seller must honour the contract.

This is genuinely different from buying a stock. Own shares and you’re fully in, unconditionally, riding every tick whether you want to or not. Stock drops 30% while you’re away? That’s your loss, and there’s nothing optional about it. With an option, the buyer has genuine optionality. If exercising the right isn’t profitable, you simply don’t exercise it. You lose the premium and nothing else. Your worst case is fixed before the trade exists.

The closest comparison in everyday life is insurance. You pay a monthly premium, and your insurer takes on the obligation to pay out if something goes wrong. Nothing goes wrong, they keep your premium. Something does, they pay. One side has a right to claim, the other has the obligation to honour it. A put option is, mechanically, insurance against a market decline. The terminology is different. The contract structure is identical.

This is worth knowing as many probably won’t know, but options weren’t originally invented for speculators. They were invented for hedgers. Farmers locking in crop prices before harvest, aiirlines capping fuel costs, fund managers protecting equity books without being forced to sell. The original buyers of options were paying for certainty, exchanging a known, capped cost upfront for protection against an unknown outcome. Traders eventually worked out you could use the same instruments to express views with far more precision than just owning the underlying, and here we are today.

Since I am going from the very basics up in this series, some of you will most likely know most of this post, but some won’t.

Calls and Puts

Everything you’ll ever encounter is built from some combination of these two.

Somehow, the definitions of a call and a put are the two definitions I know like a textbook.

A call gives the buyer the right to purchase an asset at a fixed price before a specific date. You buy calls when you think something is going up. Stock clears your fixed price, you buy cheaper than the market and pocket the difference. Doesn’t happen, and you walk away and lose the premium.

A put gives the buyer the right to sell an asset at a fixed price before a specific date. You buy puts when you think something is going down. Stock falls below your fixed price, you sell above the current market level for a profit. Doesn’t fall that far; you lose the premium.

Calls for the bulls, puts for the bears. Simple starting point.

Rights vs Obligations

Worth spelling out clearly, because the asymmetry between buyer and seller is the most important structural fact in all of options trading.

Buy an option: you have the right to act, no obligation to do anything, maximum loss is the premium paid, and your upside depends on how far the underlying moves in your favour. So the worst case is locked in before you enter.

Sell an option: you have the obligation to perform if the buyer exercises. Maximum gain is the premium you collected. If the underlying moves hard against you, the losses can be large. With a naked short call, in theory, the losses can be unlimited.

This asymmetry is the whole reason options exist as a product. The buyer pays a fixed, known amount for an open-ended right. For a binary event where you have a view but the outcome could go either way, that structure is often far cleaner than holding stock through the uncertainty. A position where your worst case is already defined is a very different psychological experience from one that can just keep going against you.

The Other Side of the Trade

For every buyer there’s a seller. This sounds obvious but most retail traders never really think about it.

When you buy a call, someone is selling it to you. That seller collected the premium and is now obligated to deliver shares at the strike price if you decide to exercise. They’re betting the stock won’t reach the strike, or at least won’t go far enough above it to outweigh the premium they collected. In most cases, that seller is a market maker or dealer, running a hedged book and making money on the spread and the mechanics of delta hedging, not on direction. Sometimes it’s an institution selling covered calls against a long stock position to generate income.

Selling options is a legitimate business. Not a dirty secret. Plenty of institutions and retail investors generate consistent returns selling premium, and it makes complete logical sense: insurance companies make money too. The seller is taking on an obligation in exchange for income, managing the risk of that obligation actively, and repeating the process. It works until volatility explodes and the losses overwhelm the collected premium.

Understanding both sides of the transaction changes how you think about pricing. When you pay $3.00 for a call, someone thought hard about whether $3.00 was enough compensation for the obligation they’re taking on. The price reflects a sophisticated assessment of probability, volatility, time, and risk. When you think the option is cheap, you’re implicitly saying you disagree with that assessment. Sometimes you’re right. However, more often you’re not. Being aware of who is on the other side and why they’re comfortable selling at that price is basic market awareness.

The Basics…

The strike price is the fixed price written into the said contract. For a call it’s the price at which you have the right to buy. For a put, the price at which you have the right to sell. Hold a $150 strike call, and you have the right to purchase the underlying at $150 regardless of where it’s actually trading. The strike is set when the contract is written, and it doesn’t change.

Expiry is the date the option stops being a live instrument. After that, the optionality is gone. If it finishes out of the money, it expires worthless. If it finishes in the money, it is exercised or settled according to the contract rules. Either way, the clock has stopped.

Premium is what you pay, quoted per share. One standard equity option contract covers 100 shares of the underlying, not one share. When you see a call quoted at $3.00, you’re paying $300 per contract. Ten contracts will be $3,000. The per-share price you see quoted and the actual money leaving your account are separated by a factor of 100. Sounds obvious, but I imagine it catches newbies constantly.

Open interest is the total number of outstanding contracts that haven’t been closed or exercised. High open interest at a specific strike means a lot of participants have positions there. This matters for understanding where large hedging flows might exist around expiry, and it’s one of the things professional traders watch when they’re trying to understand where the market might be pinned, which I’ll get into properly in Part 2.

Volume is the number of contracts traded in a session. High volume relative to open interest can signal new positioning being built, or existing positions being closed. Unusual options volume before a major move is something you’ll hear talked about constantly. Please treat it as a signal that deserves investigation, not a guarantee of anything.

Option Styles and Types

Not all options are the same contract. You need to know what you’re dealing with before you trade anything…

American Style vs European Style

Nothing to do with geography. This is about when you can exercise.

An American-style option can be exercised at any point up to and including the expiry date. Single stock options in the US are American style. A European-style option can only be exercised at expiry. Not before. You can still sell the option in the market any time before expiry, but you can’t force early exercise. Despite being an American index, SPX options, which are the most heavily traded index options in the world, are European style. Most OTC options are European style too.

The difference matters most in specific scenarios involving dividends and deep-in-the-money positions. If you’re short an American-style call on a stock paying a large dividend, there’s a real risk the holder exercises early to capture that dividend. If you’re carrying short options into an ex-dividend date without thinking about early exercise, you can find yourself with an unexpected stock position and an unexpected loss.

Cash-Settled vs Physically Delivered

When an in-the-money option expires, something has to happen. Either you receive the actual underlying asset, or you receive a cash payment based on the difference between the settlement value and the strike.

Individual equity options are typically physically delivered. If your Apple $200 call expires in the money, you receive 100 shares of Apple per contract at $200. If you’re short that call and it gets assigned, you have to deliver 100 shares. This obviously has real implications if you haven’t planned for it. Being short options that expire in the money and finding an unexpected stock position in your account the next morning is a very avoidable lesson. Although if you’re just getting started with options, I would not suggest you start selling options straight away.

Index options like SPX are cash-settled. No shares change hands. You receive a cash payment equal to the difference between the strike and the settlement value of the index. Cleaner, no delivery mechanics, no early exercise risk since they’re European style. This is a significant reason why serious options traders gravitate toward index products for anything other than single-stock views.

Exchange-Traded Options

Listed on regulated exchanges, primarily the CBOE for equity and index options. Standardised contract terms, live bid-ask spreads, transparent pricing, accessible through any standard brokerage account. The exchange acts as a counterparty through its clearing house, eliminating counterparty risk.

Weeklies, Monthlies, and LEAPS

The expiry you choose changes the character of the trade completely.

Weeklies expire every Friday. Extremely high theta decay. Very sensitive to near-term catalysts. If you’re positioning around a specific event, an earnings release, a Fed meeting, a CPI print, weeklies give you maximum leverage to that event with a premium that’s relatively cheap in absolute terms. If you’re holding a directional view with no specific catalyst in the next five days, weeklies are working against you almost immediately. Time decay in the final days of a weekly is brutal. You need to be right about direction, timing, and magnitude simultaneously. Three things at once.

Monthlies expire on the third Friday of each month. The liquid backbone of the options market for most names. Tighter spreads, more volume, better fills. Enough time for a thesis to develop without paying for excessive extrinsic value. The rational starting point for most strategies.

LEAPS (Long-term Equity Anticipation Securities) are options with expiries of one year or more. The theta decay relative to the premium paid is much lower than that of shorter-dated options. Delta behaves more like owning the underlying directly. LEAPS are normally how institutional money takes long-term directional positions using options rather than stock. Less capital deployed upfront, defined downside, full participation in a large move over a multi-year timeframe. Deep in the money LEAPS on names with genuine long-term conviction can be a more capital-efficient expression than buying stock outright. Most retail traders never even look at LEAPS because they’re focused on the weekly chain.

0DTE

Zero days to expiry. Options expiring today… What a beautiful invention.

SPX 0DTE now accounts for a remarkable share of daily CBOE volume and has fundamentally changed intraday index trading. The appeal is straightforward: massive gamma, cheap premium in absolute terms, violent moves if you get the direction right within the session.

The math is equally straightforward. To profit on a long 0DTE position, you need to be right about direction, timing within the session, and magnitude, simultaneously. Theta is decaying in real time and most 0DTEs expire worthless. There are many people who trade 0DTE profitably and systematically, running strategies that take advantage of the vol, gamma dynamics and intraday flows. But if you’re still building your understanding of how options behave, treat 0DTE as an advanced instrument that rewards experience.

Intrinsic Value vs Extrinsic Value

Every premium you pay is made up of two distinct components. I’d say that if you confuse them, you’ll spend years being confused by how your positions behave.

Intrinsic value is the real, immediately realisable profit if you exercised the option right now at the current market price. A call with a $100 strike on a stock trading at $115 has $15 of intrinsic value. Exercise it immediately, buy at $100 in a market at $115, that’s $15 per share. A $100 strike put with the stock at $85 has $15 of intrinsic in reverse.

Intrinsic value can’t go negative. The floor is zero. If your $100 call has the stock at $95, the intrinsic value is zero.

Extrinsic value (also called time value) is everything in the premium above that intrinsic figure. It’s what traders pay for possibility: the remaining time until expiry, the uncertainty about where the underlying ends up, and the implied volatility expectations baked into the option’s price. A $100 call with $15 of intrinsic trading at $18? That extra $3 is extrinsic.

So here is the critical mechanical fact about extrinsic value: it decays every single day, without exception. At expiry, it goes to zero. The option is worth only its intrinsic value at that point. No intrinsic value means worthless. A stock can go nowhere for two weeks, and the option holder still loses money just from time passing which isn’t unusual. That’s the product doing exactly what it was designed to do. The decay of extrinsic value is called theta, which I’ll cover in depth in Part 2. For now, just understand: time is not neutral for option buyers. It runs against them every day.

ITM, ATM, OTM

Three states. You’ll use these every time you look at a chain.

In the money (ITM) means the option has intrinsic value right now. A call is ITM when the stock is above the strike. A put is ITM when the stock is below the strike.

At the money (ATM) means the strike is close to where the underlying is trading. No intrinsic value, but the highest uncertainty of any strike on the chain. Nobody knows whether it expires in the money or not. ATM options carry more extrinsic value than any other strike and they’re the most sensitive to everything: moves in the underlying, changes in implied volatility, time passing. Watch ATM options closely, and you’ll learn more about how options actually behave than by reading any number of explanations.

Out of the money (OTM) means no intrinsic value yet. The underlying hasn’t reached the strike. OTM options are cheaper in absolute premium terms, which makes them look appealing, and I’ll get into why that’s often a trap.

Moneyness isn’t fixed as it shifts with every tick. An ATM call becomes ITM if the stock rises, and an OTM put becomes ATM as the stock falls toward the strike. The option’s behaviour, its sensitivity to moves, its time decay, all of it changes as moneyness changes.

How Options Are Actually Priced

This is the section most retail traders never encounter or get to read a simple explanation of. Yet it’s the one that changes how you think about every trade you’ll ever place.

An option’s price is a probability distribution made tradeable.

When you buy a call you’re not just buying the right to purchase stock at a fixed price. You’re paying for the probability-weighted expected value of that right at expiry. The market is effectively asking: given everything we know about this stock’s likely behaviour, what is the expected value of owning this right?

The theoretical pricing framework works roughly like this. Take all the possible prices the stock could reach at expiry. Assign a probability to each outcome. Multiply each outcome by its probability and add them all up. The result is the expected value of the option. The premium you pay is roughly the present value of that expected value, adjusted for interest rates and carrying costs.

So the premium is not arbitrary. It reflects a sophisticated probability calculation. So remember that every time you buy an option, you’re implicitly saying that you think the market is wrong about these probabilities.

There are six key inputs into any standard option pricing model. The current stock price, the strike price, the time to expiry, the risk-free rate, any dividends expected before expiry. And of course, volatility.

Five of those six inputs are either fixed or directly observable in the market. Volatility is the exception. It has to be estimated. And since nobody knows exactly how volatile the stock will be over the life of the option, different traders will have different estimates. The volatility assumption is where all the real disagreement lives, and it’s where professional options traders actually make their money. Not on direction bets but on being right about volatility when the market is wrong.

The volatility figure plugged into a pricing model gives you a theoretical value for the option. The actual market price is determined by supply and demand. When the market price is above the theoretical value based on your volatility estimate, the option is overpriced relative to what you think is fair. Professional traders are constantly running this comparison, asking not just “what does this option cost?” but “relative to what I think vol is going to do/be, is this option cheap or expensive?”

Most retail traders will never ask that second question. They look at the dollar cost of the premium and decide whether it feels cheap or expensive based on their gut feeling about the stock. Whereas a professional is making a far more precise assessment: is implied volatility too rich or too cheap relative to my expectation of how much this stock is actually going to move?

Implied Volatility (Implied Vol)

Implied volatility deserves its own section because it’s probably the most important concept in options trading that surprisingly so many consistently ignore or don’t know enough about.

When people talk about implied vol, they’re talking about the volatility level that, when fed into a pricing model, produces the observed market price for an option. It’s the market’s consensus estimate of how much the underlying will move between now and expiry, expressed as an annualised percentage.

If SPX options are pricing implied volatility at 20%, the market is effectively saying it expects the index to move roughly 20% annualised over that period. A 20% annualised vol on a 30-day option implies a daily move of about 1.25% and a monthly move of roughly 5.8%. These are rough guides, not guarantees, but they give you a sense of what’s baked into the premium.

Implied volatility is not constant across all strikes or all expiry dates. Different strikes at the same expiry trade at different implied volatilities. For most equity indices, OTM puts trade at higher implied volatility than ATM options, which trade at higher implied volatility than OTM calls. This shape is called skew, and it reflects a structural reality: markets normally price downside risk more expensively than upside potential because large down moves tend to happen faster and more violently than large up moves. I’ll go more into depth on this in Part 2.

What you do need to understand right now is that when you buy an option, you’re simultaneously buying direction and buying volatility. The premium you pay reflects both. And if implied volatility is elevated because a catalyst is approaching, like earnings or a Fed meeting, you’re paying an expensive premium that reflects uncertainty the market has already priced in. When that event resolves itself and the uncertainty disappears, implied vol will come off, and that collapse can overwhelm any directional gain you made.

This is what is known as a vol crush. It happens after most scheduled events.. Earnings, Fed meetings, Jobs data, CPI prints. Implied vol spikes into the event, then collapses after it. Buying options into these events means you’re paying peak uncertainty and then watching that premium evaporate even as the stock/index moves your way. I’ll go deeper into event vol and how to think about it in Part 2.

IV rank and IV percentile are the two most commonly used tools for contextualising implied vol. IV rank tells you where current implied vol sits relative to its range over the past year. An IV rank of 80 means implied vol is currently higher than 80% of its readings over the past twelve months. An IV rank of 10 means it’s near the bottom of its historical range. IV percentile is similar but measures what percentage of days in the past year saw implied vol below the current level. Both are imperfect, but give you a quick sense of whether you’re buying or selling premium at an historically elevated or compressed level.

Put-Call Parity: Why a Call Is a Put

Here’s something that so many never learn, and one of the things people don’t fully understand, ever, I don’t think.

Calls and puts on the same underlying, at the same strike, with the same expiry, are mathematically bound together. The relationship is called put-call parity and the punchline is this: a call option combined with enough cash to cover the strike price at expiry is exactly equivalent to a put option combined with owning the stock.

In practical terms, this means you can build a synthetic long call using a long put and long stock. You can build a synthetic long put using a long call and short stock. Every basic options position has a synthetic equivalent, and the two must be priced consistently with each other. If they diverge, there’s an arbitrage, and the market will close it almost instantly.

Why does this matter to me, you ask…

First, it means option prices are not independently set. When the call at a given strike moves, the corresponding put must move in step to maintain parity. Both reflect the same implied vol for that strike. They’re not two separate market views. They’re two expressions of the same probability distribution.

Second, it means you can always find the most efficient way to express your view. If you want to be long a call but the call seems expensive, check whether you could synthetically replicate it more cheaply via a put plus stock.

Third, it will give you an intuition for why dealers run their books the way they do. A dealer who is short calls and a dealer who is short puts at the same strike are, after hedging, managing essentially the same underlying risk expressed in different forms. The flow that results from their hedging affects the underlying stock or index in predictable ways…. This is the foundation of what we’ll cover around dealer gamma in Part 2 and maybe Part 4.

“Cheap” Options Are Usually Expensive Lessons

This one has cost me, and it costs almost everyone.

As I said earlier, OTM options are cheap in absolute dollar terms. It’s easy to see the appeal. But when you buy an OTM option, you’re buying a bet the market has already priced to lose most of the time. This is a fact. The price of that option reflects the market’s probability estimate of it expiring in the money. A call with a delta of 0.20 (and I will explain delta properly in Part 2, honestly, Part 2 of Zero to Stock Hero was better than Part 1… this is becoming a theme) A call with a delta of 0.20 is often used as rough shorthand for something like a 20% probability of finishing in the money. It is not mathematically perfect and it is not a real-world forecast, but it gets the beginner’s point across: the market is not treating that outcome as the base case. Four times out of five, by the market’s own probability assessment, it expires worthless.

The market prices options on what they’re worth in probability-weighted terms. You’re not finding a bargain when you buy a cheap OTM option. You are buying something the market has already priced to fail more often than it succeeds.

For that bet to work in your favour consistently, one of two things needs to be true. Either the market’s probability estimate is wrong (the stock is actually more likely to make that move than the price implies), or your payoff when you win is large enough to compensate for losing four times as often. Both can be true. Very rarely are retail traders buying OTM calls thinking about either of them. They’re looking at the $0.50 premium and imagining it becoming $5.

Then you have to add time to it. The OTM option doesn’t just need a big move, it needs that move to happen before expiry. A weekly OTM call bought on Monday that hasn’t moved by Wednesday has already bled a meaningful chunk of its remaining value just from a few days passing, regardless of what the underlying did. Right about direction, wrong about timing. Still expires worthless…

Cheap in premium is not cheap in probability. Separate those two things and you’ve already eliminated one of the most common and avoidable ways to lose money with this instrument.

The Four Things You’re Actually Trading

Buy a stock and you’re trading one thing, which is direction. Up or down. That’s the only variable. Everything else is noise you ride through.

Buy an option and you’re trading four things simultaneously, whether you realise it or not. Most retail traders are only thinking about one of them. But the market prices all four, every single trade, every day.

Direction. The obvious one. Bullish or bearish on the underlying. Necessary but not sufficient. And critically, you need to be right about direction AND speed. A trader who is right that a stock goes from $100 to $120 eventually makes money regardless of whether it takes two months or two years. An options trader who buys a call expiring in three months and the stock reaches $120 in month four loses money. Right on direction, wrong on timing. The option already expired. Womp womp…

Volatility. Baked into every premium. Buy when implied vol is elevated and you’re paying an expensive premium that reflects expectations of large moves. Buy when implied vol is low and you’re getting in cheaply. You can be completely right about the direction something moves and still lose money because you bought expensive vol that subsequently collapsed. You can also make money even when the underlying barely moves, if you bought options when implied vol was cheap and it subsequently expanded. Vol is a tradeable asset in its own right, completely independent of direction.

Time (theta). Not neutral. It runs against the buyer every day, in one direction only. Longer-dated options give your thesis more room to play out. Shorter-dated options demand precision on timing as well as direction. Every day you hold an option and the underlying doesn’t move in your favour, you’re paying theta. It’s the cost of owning the right. Some days, that cost feels negligible. In the final week before expiry, it can feel enormous.

Path. This one surprises people. Hold a stock through three weeks of choppy sideways action before it finally breaks out on day 22? You’re fine, the stock is at your target. Hold a short-dated call through those same three weeks? Theta has eaten most of your extrinsic value. You got there, but not fast enough, and the option that was worth $3.00 when you bought it might be worth $0.80 by the time the stock finally moves. Direction was correct. Path and timing cost you most of the profit.

Every options trade is a simultaneous bet on all four. The market prices all four, and all four show up in your P&L. Trading options as if they’re just leveraged stock is the single most common and most expensive mistake in options trading.

Payoff Diagrams

You’ll see these in every piece of options education, so here’s what they actually show and, importantly, what they don’t.

A payoff diagram plots the PnL of an options position at expiry against different prices of the underlying. Underlying price along the bottom axis, P&L on the vertical axis. The line tells you what the position is worth when time finally runs out.

Long call: flat line on the left at the level of the premium paid, your maximum loss. Stays flat until the underlying reaches the strike. Above the strike it slopes upward. Breakeven is strike plus premium paid.

Long put: mirror image. Flat line on the right at premium paid. Below the strike the line slopes upward in profit terms. Breakeven is strike minus premium.

Short call: flat line at the top representing the premium collected, your maximum gain. Below the strike you keep everything. Above it, losses rise without a ceiling.

Short put: flat line at the top representing the premium. Above the strike you keep everything. Below it, losses build as the underlying falls.

What payoff diagrams don’t show you is everything that happens before expiry. They’re a snapshot of one moment in time: the last moment. In practice, the option’s value changes every day as the underlying moves, as time bleeds out, as implied vol shifts. The diagram shows you the destination. But says nothing about the journey. And the journey is where you actually live as a position holder. You might be sitting on a large profit at expiry and have experienced a 60% drawdown in the position getting there. The diagram won’t tell you that. Useful for understanding the basic shape of a trade’s risk and reward. Not a complete picture of a live position’s behaviour.

A good site to understand how options behave is optionstrat.com. You can see the payoff profiles in action. Visualise how it will behave across different prices, dates and vol scenarios. Genuinely a useful free tool, especially when you start combining legs.

Why Most Beginners Blow Up Buying OTM Calls

I’ve heard this happen so many times it almost feels scripted at this point.

Someone is bullish on a stock. They look at the chain and see the ATM call at $4.00 ($400 per contract), and say an OTM call two strikes higher at $1.00 ($100 per contract). They buy the OTM call. Smaller outlay, bigger percentage gain if they’re right, feels like better risk-reward on paper.

Little did they think… the OTM call has a lower delta. Thus is less responsive to moves in the underlying. The stock has to travel past the strike before the option generates meaningful intrinsic value. While the ATM call participates in every move from day one and the OTM call just waits for a move large enough to matter. Also, OTM options are more exposed to time decay as a percentage of their value. That $1.00 call is almost entirely extrinsic. All of it is decaying every day. One sideways week and it can lose 50% of its remaining value. The ATM call decays too, but proportionally less of a larger premium.

Oh, and of course, this is the one that really gets people: the $1.00 price makes them buy more contracts. Four OTM contracts at $100 each instead of one ATM at $400. Same total spend, feels like more exposure and more potential upside. What they’ve actually done is multiply their time decay and volatility risk by four. When it goes wrong, it goes wrong four times as hard.

The result: stock moves up 3%, which directionally feels like a win, but the OTM strike hasn’t been reached, theta has eaten most of the remaining extrinsic, and the position is worth less than what was paid despite a correct directional call.

This is the most common options story in retail trading - quiet, grinding erosion of capital in positions that felt smart but were structurally stacked against the buyer from the start.

Exercise and Assignment: What Actually Happens

I assume that most retail traders never think about exercise and assignment until it happens to them unexpectedly. Then I’d guess it’s memorable.

Exercising means using the right you purchased. If you hold an ITM call at expiry, you can exercise it, pay the strike price, and receive 100 shares of the underlying per contract. If you hold an ITM put you can exercise it, deliver 100 shares, and receive the strike price per share.

Assignment is what happens to the seller when the buyer exercises. If you sold a call and the buyer exercises, you get assigned: you must deliver 100 shares at the strike price, regardless of where the stock is trading (if you don’t own the stock - you are now short). If you sold a put and the buyer exercises, you must purchase 100 shares at the strike price, regardless of where the stock is trading. If you don’t own the stock already, you do now.

In practice, most option buyers never exercise their options. They sell them in the market before expiry. The reason is straightforward: when you exercise an ITM option you receive only the intrinsic value. When you sell it in the market you receive the intrinsic value plus whatever extrinsic value remains. Exercising destroys the extrinsic value, whereas selling captures it. So, unless you specifically want to own the shares or there’s a specific reason to exercise early, you’re almost always better off selling the option.

The exception to this is with American-style options in specific circumstances.

Early exercise sometimes makes sense for deep ITM calls when a large dividend is about to be paid. If you hold a deep ITM call and the company is about to pay a dividend large enough that the value of the dividend exceeds the remaining extrinsic value in the option, it can make sense to exercise early to capture the dividend. This is called dividend arbitrage, and it’s why call holders sometimes exercise the night before an ex-dividend date.

Early exercise for deep ITM puts can also make sense when the option is so deep in the money that the remaining extrinsic value is minimal and the interest you could earn on the proceeds of exercising (receiving cash from the strike price) exceeds that remaining extrinsic. Rare in practice but it happens.

The assignment risk for short options is the more important thing to understand for most. If you’ve sold calls or puts that expire in the money, you may be assigned. This can happen at any point for American-style options, not just at expiry. Going into an ex-dividend date with short ITM calls is a particular risk because holders may exercise specifically to capture the dividend.

The Friday Lotto Exception

Now, before someone points out the obvious: yes, I enjoy the occasional Friday lotto.

A tiny 0DTE or weekly option punt risking 5-10bps of NAV is one of life’s simple pleasures. Markets are meant to be taken seriously, but not every trade has to be written up like a pension fund allocation memo.

There is nothing inherently wrong with buying a lottery ticket, as long as you know it is a lottery ticket. A 5bps Friday punt is entertainment with defined downside. In fancier terms, it is a small, pre-budgeted convexity bet. If it expires worthless, who cares?

But when someone takes that same idea and sizes it like a real position, they are outsourcing their dopamine system to the option chain.

What I am trying to say here is that there’s a difference between “I am risking 5bps for a bit of fun” and “I am risking meaningful capital on a short-dated OTM option because I saw a chart on Twitter and think this could squeeze.”

So yes, options can be lottery tickets. But lottery tickets belong in the lottery-ticket bucket. Sized like they are going to zero, because a lot of the time, they are.

When Options Are Actually Useful

Options get a bad reputation because most people encounter them through the speculative side first. Which is not what they were built for.

Defined risk on binary events. Earnings, a regulatory decision, central bank meeting. You have a view but the outcome could go either way, and the stock could gap significantly. Buying an option defines your maximum loss before you enter. You can’t lose more than the premium. For events with real gap risk in either direction, the structure is often far cleaner than holding stock through the uncertainty and hoping.

It’s leverage with a floor. A $200 call on a $100 stock controls $10,000 of notional exposure. Unlike leveraged futures or CFDs, the loss can’t exceed the premium paid. The leverage exists within defined limits. Used properly, it’s a meaningful structural advantage over other leveraged instruments.

Hedging without selling. This is why the instrument was invented as mentioned earlier in the post, and where serious money uses it most rationally. Long a large equity book and worried about a correction? Puts cap your downside without forcing you to liquidate positions you want to hold long-term. The premium is the cost of that protection. Whether it’s worth paying depends on how expensive the protection is relative to the risk you’re trying to manage. More on this in the following volumes…

Income generation through selling. Covered calls against long stock positions. Cash-secured puts on names you’d genuinely want to own at the strike. Structured premium harvesting programmes. In the right volatility environment, with proper sizing and active management, it’s a legitimate income source. However, I would say it’s a full-time job with real tail risk that needs to be managed seriously.

Convexity. Options have non-linear payoffs. A large move in the underlying produces a disproportionately larger gain than a small move would suggest, because gamma accelerates the position in your favour as it moves your way. When you’re long options and the market makes a genuinely large, fast move in your direction, you make significantly more than a linear instrument would give you. For tail risk positions, for macro views where you expect the magnitude of a move to be larger than what the market is pricing, the convexity of long options is genuinely powerful.

Expressing a volatility view. This is something that simply doesn’t exist in stock or futures markets. You can have a view that a stock is going to move a lot without knowing which direction, or that it’s going to move less than the market expects, and express that view directly through options without any directional exposure at all. The ability to trade vol as an asset class independently of direction is one of the things that makes options markets unique.

So if you’ve never traded options… here are a few things worth having internalised before you do.

Know what probability you’re paying for. Every premium is a probability estimate. Cheap OTM options are cheap for a reason. Before buying anything, ask yourself honestly: do I think the market is wrong about that probability? If yes, why specifically? If no, there’s your answer…

Check implied vol before you enter. Is IV elevated versus its own recent history? If yes, you’re buying expensive vol that’s about to be crushed. Is IV near multi-month lows? You might be buying options relatively cheaply. This literally takes you less than a minute, and it changes the analysis completely.

Treat time as a real cost. Every day you hold an option without a favourable move in the underlying, you’re losing money on the extrinsic decay. You can’t buy a call and wait indefinitely for your thesis to eventually play out. There’s no eventually, there’s expiry.

Should be obvious, but I’ll say it anyway… size relative to total capital, not per-contract premium. Twenty OTM calls, because each one costs $100 is not necessarily a small position (this all depends on the size of your book, of course).

Have a plan before entering. Where does the underlying need to go, by when, for this to work? What are you doing if it doesn’t? What are you doing if it gets there faster than expected and implied vol collapses? Options without an active management plan tend to decay quietly into losses. Unless you trade them like me, which is prem paid = max loss in most cases… but we will get to this later in the series, where I will try to share how I trade options and give some examples.

What Comes Next…

Greeks, Implied versus realised vol. IV rank and percentile. Skew and term structure. Event vol and the crush. Expected moves. Why buying calls before earnings is often much harder than it looks. Dealer gamma and how large option positions can create predictable behaviour in the underlying.

Once you understand the Greeks and the vol surface, options stop being confusing and start being a product you can actually read.

Part 3 I plan to delve into spreads, risk reversals, calendars, position sizing, when to buy premium and when to sell, how to manage winners, and so on…

If this was useful, the like button is right there. Restacks help other people find this instead of whatever they’re currently being told on YouTube.

See you in Part 2.

Fed

One thing I had to learn through actual losses: being right about direction is one of the four things you need to get right in options. Most people understand this intellectually when they read it. But almost nobody internalises it before it costs them money. I hope this post shortens that particular curve for some of you.

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If you're new here, the Zero to Hero series covers FX and Equities too.

Lord Fed's Gazette

From Zero to Stock Hero

In markets, you're not rewarded for knowing what's next - you're rewarded for surviving what's next…

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a year ago · 319 likes · 15 comments · Lord Fed

Lord Fed's Gazette

From Zero to FX Hero

In the time it takes to read this sentence, over $300 million in currencies will change hands worldwide. Welcome to the world of FX trading, where global currencies never sleep. With over $7 trillion changing hands daily, it's the largest and most liquid market out there. Whether you're just starting to trade currencies or you're keeping tabs on FX for …

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a year ago · 302 likes · 25 comments · Lord Fed

Let me show you the scoreboard first, because it buys me the right to say the uncomfortable thing that comes after it.

The SNOW 180 Jun calls I shared with subscribers before earnings at 6.9 (and allocated 70bps of NAV) last traded at 100.7, I am still carrying a quarter of the original size.

The Phase 3 basket (20% weight) has gone from +12.6% when I last wrote to +35% since I shared the basket in late March, doing exactly what I said it would.

From the last time I wrote, my top weights have done the following…

ORCL (10% weight) 186 to 248. CRDO (5% weight) 156 to 223. I also bought some 170 weekly calls in the dip at 3.5, which settled at 48.33… I took the delivery and sold the delivered stock shortly afterwards. Last night, it reported earnings and knee-jerked 15% down, as I type this, it’s barely down one. Bottleneck is doing what bottlenecks do.

MSFT (7% weight) 416 to 460, with the short 380p I am carrying against it quietly melting into irrelevance.

CRWV was put on ten days ago at 5% weight at 107, now trades at 125.

TEAM put on last quarter at 5% weight was 85 the last time I wrote, now 116.

NOW also put on last quarter at 5% weight was 99 the last time I wrote, now trades at 135.

The 70/90 Jun IGV risk reversal I put on for a credit is now 17 dollars ITM on the call strike.

The list genuinely goes on. Some may say I am victory lapping, maybe I am, but it’s been an incredible quarter, and now we enter the final month of it. I can’t sit here and act like you get many markets like this; you don’t. But when you do, the correct response is not false modesty, but to ask why it happened, whether it can continue, and what the market is about to bid next.

Dispersion has once again proved itself to be the most profitable condition of the spring. The software melt-up every desk has spent the past week trying to explain (IGV up double digits in a few sessions) is the same Phase 3 idea I wrote back in late March. Thus far, the software bid has been nothing but a cover bid. The AI-replacement bear case got way too loud. And so many of these names were too cheap versus their own cash generation.

Now, before you assume this post is going to be me finally climbing into the bear suit, it’s the opposite. The honest and repeatedly back-tested conclusion is that being stretched has not been a tradeable sell at all in this market, and the most likely surprise from here is a further melt-up driving a huge stop-in. So yes, I continue to look up and to the right.

So in this post, I'll share some fresh high-conviction trade ideas and where I think this market is heading next.

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I’ve been doing this long enough to know exactly when my own calls start making me nervous, and it’s actually not when they’re wrong. It’s when they’re right, and the people who told me I was an idiot for making them six weeks ago are now repeating the thesis back to me with slightly different wording, like it was the original thought. I guess that’s where we are right now.

This rally has been so clean that the same machinery now makes the reverse direction equally efficient, and almost nobody is paying for the right to be on the other side of it. Long gamma in the dealer book has been the most recent structural bid. Index vol has been pushed to levels that, in any other context, you'd be calling a gift if you expect a puke. Overwriters keep selling calls into a tape that's grinding higher, getting forced to cover and roll. Levered ETF AUM is enormous and rebalances daily in the direction of the move. And the underweight discretionary cohort has spent six weeks losing the argument with price and is now buying, late and undoubtedly a bit bitter about it. Every one of these flows is reflexive. The problem with reflexive bids is they're also reflexive offers… same door, just the opposite direction.

My Phase 3 basket is very much alive and will become even more so if semis come off. Phase 3 is effectively a short momentum trade right now, so when momentum comes off, the names rally. I don’t monitor 13Fs all that much, but there are some noticeable buys in the software space, specifically in a lot of Phase 3 names - so you could argue the names are in an accumulation phase. In case you missed the Phase 3 post, I have linked it below.

What’s changed in the past week is that something about the feel of last week has made me sit down and write a different kind of post this week. Just thoughts on my mind, a quieter post that if you only read the title, you’d assume I’ve lost my nerve (which I haven’t).

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I have been trying to work out what actually changed last week, because the obvious answer is not good enough. Yes, the market went up again and tech led again. Yes, semis and memory went vertical. And yes, the underweight crowd has run out of clean ways to describe the move without sounding like they have completely missed it.

The thing that’s standing out here is that the buying has started to look less like conviction and more like admission. Conviction will buy because it wants to, whereas admission buys because it has to. Conviction normally has a plan, whereas admission normally just has a sentence it repeats to itself while paying a worse price than it could have a few weeks prior.

I don’t think we are in a clean beautiful bull market where everyone has done their homework and had the realisation that the AI capex cycle deserves a higher multiple. It would be nice, but it would also be bullshit.

What I think is actually happening is much simpler than that. The market has gone just far enough for long enough in exactly the wrong names for a lot of people, that the ones who hated the move now have to buy the thing they spent six weeks calling stupid. This is not the most hated rally; it is the most humiliating. At some point, “I want a better entry” becomes a confession, and I’d argue we are somewhere around that point, which is exactly when the trade gets harder, not easier.

The first phase of this rally was basically survival. Don’t puke the book. Don’t short the recovery because you read three posts about breadth and don’t pretend every geopolitical headline is a secular regime change. Oh and don’t sell the companies still printing earnings. And you were fine. It’s not quite enough now.

Not a lot to update on my book, Phase 3 had a great week last week as did some of the derivatives I hold. I cut the long call leg of the 6500/7000 risk reversal. FSLY got hit post-earnings, not overly concerned with the position being at 2% weight, but a small annoyance since I thought it was about to break out and up. Last week was a good week. This week is the harder question.

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But I have spent the last few days going through the positioning, flow and sentiment data and I do not love what I am looking at. Not in the lazy “the market went up so it has to come down” way that I have been arguing against for some time as that argument is still wrong, and the people running it are still going to get hurt. The conditions that drove the rally are quietly changing, and the next dollar of risk in this book is no longer a long. It is a hedge.

The CTA bid is mostly done. GS has CTAs long around $44B of US equities and over $100B globally, that was your giant bid recently, and it has done a lot of work. Systematics bought almost $80B of US equities over the past month, the second-largest one-month re-levering on a ten year lookback. That tailwind is largely behind us, and the short-term and medium-term SPX pivots now sit around 6,930 and 6,820, which means a real break of either turns a friendly positioning backdrop into mechanical supply uncomfortably fast.

The Nasdaq just had its best month since 2002, and semis their best since 2000. None of that is a sell signal on its own, but stacked together it is the kind of backdrop where the market loses its margin for error.

Retail has moved along with it. Participation in SOXL is sitting at the 99th %ile on a five year lookback, QQQ just had its biggest monthly inflow ever, semiconductor ETF AUM has crossed $100bn, and the dip-buying behaviour from a month ago has quietly been replaced by chase mania.

So you stack it up. CTA bid, sentiment stretched, retail trading in vast volumes, and everyone is suddenly more interested in upside than they were 800 handles ago, which is not the same market I was writing about a month ago.

I have been the most bullish voice in your inbox. I had my hedges on, I didn't puke half the book out in panic, and I was right. But the conditions are no longer what they were, and I think a lot of people are about to learn the hardest lesson in markets, which is that being right on direction is not the same as making money.

For context, here are some marks from the book that have been doing the talking.… The 6500/7000 risk reversal I put on for 18 credit is at 312. The September 5,900 put I wrote for 188 trades at 52. TEAM is up 24% in a week at a 5% weight (still offside though). FSLY is up 11% as a fresh long that I paid 26.5 for last week. Phase 3 was up around 2% on the week with DDOG +8.5%, VEEV +6.5% and WDAY +6% leading the basket.

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