Eugene Linden
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Matt Taibbi, a journalist whose writing I admire, has joined the throng decrying the hypocrisy of pundits who write on the pages of the Washington Post (owned by a billionaire) that if billionaire Elon Musk buys Twitter it will be a threat to democracy. This is too glib. The problem isn’t b...



Fire & Flood
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Deep Past
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endangered animals
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The Ragged Edge of the World

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Afterword to the softbound edition.

The Octopus and the Orangutan
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The Future In Plain Sight
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The Parrot's Lament
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Silent Partners
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Affluence and Discontent
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The Alms Race
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Apes, Men, & Language
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Friday August 19, 2016

Joe Farnam, the dogged, data-driven discoverer of the ozone hole, died in 2013, three years before publication of findings showing that the ozone layer, which protects life on earth from UV radiation, has finally started to recover. This nascent recovery comes 42 years after atmospheric chemists first raised alarms about the threat chlorine compounds posed to this fragile shield, 34 years after Farman first saw an alarming drop in ozone in Antarctic, and 29 years after the world’s nations took action to phase out the chemicals, and it will still be decades before the ozone layer recovers completely. Were it not for Farman, the international community might not have taken action, and the world would be a far different place today, with unchecked UV radiation spreading cancer and havoc among humanity and devastating ecosystems and the food chain. It’s also worth revisiting this history because the struggle to identify and come to grips with this threat prefigured all the themes of the still-unresolved question of dealing with another man-made threat: climate change.
In 1982, when Farman’s monitoring equipment first showed a dip in ozone, he was tempted to dismiss the readings as instrument error. At that point, ozone levels had been stable for 25 years. A recheck validated the findings, however, and subsequent years showed an alarming acceleration in the deterioration of the ozone layer.
It was no mystery for scientists what was causing the decline. Eight years earlier, atmospheric scientists Sherwood Rowland, Mario Molina, and Paul Crutzen had published articles documenting that the release of certain chlorine compounds could start chemical reactions that destroyed atmospheric compounds. They won a Nobel Prize for their discovery. Later, prefiguring the playbook of climate denialists today, Congressman Tom Delay disparaged the award as the “Nobel Appeasement Prize.”
Even before Delay’s attempts to delay action on protecting the ozone in Congress, the industry, led by DuPont, which dominated the production of CFC’s (the chemicals deemed to destroy ozone), had organized a lobbying effort to discredit the science. They helped found The Alliance for Responsible CFC Policy in 1980, which challenged the scientists at every turn, spread alarm about the economic consequences of a CFC ban, and sowed disinformation in the media. They realized that given the inertia of American politics, they didn’t have to disprove the science. All they had to do was to argue that the science was inconclusive.
This was the exact same playbook used in the next decade by the Global Climate Coalition (also founded by Dupont), as well as numerous fossil fuel industry lobbying groups in so-far successful efforts to delay action on climate change. Indeed, a good number of the scientists who disparaged the threat of CFCs, including Fred Singer, Richard Lindzen, and Patrick Michaels, later turned up as leading climate change deniers.
In a typical example of industry casuistry, DuPont officials argued in the mid-1980s that no action was necessary because the market for CFCs was flat. What they well knew was that it only looked flat because a severe recession in 1982 distorted the figures, while, in fact, growth was accelerating as the economy recovered and emerging nations looked to increase refrigeration (CFCs were used as a refrigerant).
Once the evidence became incontrovertible, DuPont flipped and became an advocate for banning CFCs. While the action looked noble, DuPont had started developing alternatives to CFCs in the 1970s and had a huge lead on competitors. One wonders whether DuPont would have given its support for the 1987 Montreal Protocol if it were not to their economic advantage.
There are three lessons from the ozone chronicles, all of which have been ignored thus far in the struggle to deal with climate change:
1)   Industry requires regulation. In their no-holds barred attack on the scientists, duplicitous use of disinformation, and lobbying power, the chemical industry showed that all their executives cared about was profits, even if those profits came from chemicals that posed a threat to life on earth. Yet the mood in recent years has been decidedly anti-regulation.

2)   Politics matters. DuPont began to develop alternatives when Rowland and others showed the link between CFCs and the destruction of ozone. They tabled these efforts when Ronald Reagan was elected because they assumed no regulation was coming. In the U.K., the incoming Thatcher administration almost eliminated Farman’s ozone monitoring operation in a cost-cutting effort. How much more damage to the ozone layer might have occurred before some other agency discovered the problem? Today, Australia is considering the shut down of some of its ocean and atmospheric monitoring, vital to our understanding of climate change, in an effort to redirect science towards more commercial applications.

3)   Basic science matters. Were it not for the 25 years of data Farman had collected prior to 1982, he and his colleagues might not have noticed that something unprecedented was happening to the ozone layer. Before Rowland, Molina and Crutzen did their work, CFCs were regarded as entirely benign chemicals. It took basic science to make the leap connecting refrigerants in kitchens to the health of an atmospheric shield.  As we introduce more and more novel compounds into daily life, we need such imaginative scientists to determine whether they might also pose novel threats. Yet, both EPA and research budgets are continually under threat. The world remains one short-sighted budget cut away from blithely ignoring some new novel threat. Trouble is, we don’t know which cut it will be.

The world owes a huge debt to the diligence of Joe Farman who doggedly pursued what most would regard as mind-numbing data collection in the face of public indifference and political hostility. We need his successor now more than ever.

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Short Take

HOW THE OPTIONS TAIL HAS COME TO WAG THE MARKET DOG: A Simple English Language Explanation of How Structural Changes in the Stock Markets Contribute to Whipsaw Movements in Prices.

Lately a string of violent price movements and reversals in the equity markets make it look like the markets are having a nervous breakdown. The last day of trading in April 2022 saw a 939 point drop in the Dow. The day before that, the Dow rose about 625 points, and two days before that it fell over 800 points. The very next week, after two quiet days, the Dow rose over 900 points after the Fed announced its biggest rate hike in 22 years (ordinarily a big negative for the markets), and then, the next day, fell over 1000 points (more on this later).  There have been plenty of headlines – about the Ukraine Invasion, inflation, the threat of a Fed caused recession, supply chain disruptions – to justify increased uncertainty, but the amplitude of the moves (and the sudden reversals) suggest something more may be at work. Here follows an effort to explain in simple language the significant changes in the market that have contributed to this volatility.


“This time it’s different” is perhaps the most dangerous phrase in finance as usually it’s uttered by market cheerleaders just before a bubble bursts. That said, markets do change, and those changes have their impacts. One change in the markets has been the shift from intermediaries (such as brokers) to direct electronic trading, a shift that has made the markets somewhat frictionless, and allowed computer driven funds to do high speed trading. This shift began a couple of decades ago. Today’s markets can move faster than a human can react.


Another shift has been the degree to which passive investing through index funds and algorithmic trading through various quant funds have come to eclipse retail investing and dominate trading. A consequence of this is that to some degree it has mooted individual stock picking because when investors move in or out of index funds, the managers have to buy or sell the stocks held on a pro rata basis and not on individual merit. This change too has been developing over recent decades.


A more recent and consequential shift, however, has been the explosion in the sale of derivatives, particularly options (the right to buy or sell a stock or index at a specified price on or before a specific date). Between 2019 and the end of 2021, the volume of call options (the right to buy a stock at a specified price on or before a particular date) has roughly doubled. During times of volatility, more and more retail and institutional investors now buy calls or puts rather than the stocks. 


Today, trading in options has reached a scale that it affects market moves. A critical factor is the role of the dealers who write options and account for a significant percentage of the options issued. Dealers have been happy to accommodate the growth in option trading by selling calls or puts. This however, makes them essentially short what they have just sold. Normally, this doesn't matter as most options expire out of the money and worthless, leaving the happy dealer to book the premium. Being short options, however, does begin to matter more and more as an option both moves closer to being in the money and closer to expiration. 


This situation is more likely to occur when markets make large and fast moves, situations such as we have today given the pile of major uncertainties. Such moves force dealers to hedge their exposure. 


Here’s how it works. If, for instance, a dealer has sold puts on an index or a stock, as a put comes closer to being in the money (and closer to expiration), the dealer will hedge his short (writing the put) by selling the underlying stock. This has the combined effect of protecting the dealer -- he's hedged his potential losses – while accelerating the downward pressure on the price. In other words, this hedging is pro-cyclical, meaning that the hedging will accelerate a price move in a particular direction.


Traders look at crucial second derivatives of stock prices, referred to by the Greek letters delta and gamma to determine exposure to such squeezes. As an option moves closer to in the money it's delta -- it's price movement relative to the price movement of the underlying, and its gamma -- the rate of change of the delta relative to a one point move in the underlying, both rise. The closer to both the strike price and expiration date, the more the dealer is forced to hedge. The result is what’s called a gamma squeeze. Once the overhang of gamma exposure has been cleared, however, the selling or buying pressure abates, and gamma may flip, with new positioning and hedging done in the opposite direction. The result can be a whipsaw in the larger markets. This same phenomenon can happen with indexes and futures.


How do we know that the hedging of option positioning are contributing to violent price changes and reversals in the market? While not conclusive, perhaps the strongest evidence is that large lopsided agglomerations of options at or near the money have been coincident with surprising market moves as expiration dates approach. In fact, some market players use this data to reposition investments, in effect shifting investment strategy from individual companies to the technical structure of the markets. This is what Warren Buffett was referring to when, at his recent annual meeting, he decried the explosion of options and other Wall Street fads as reducing companies to “poker chips” in a casino.


The week of the May Fed meeting gave us a real-time example of how a market move that looks insane on the surface reflects the underlying positioning in various derivatives. To set the stage: ordinarily, given debt burdens and the threat of recession, the markets would be expected to react badly to a Fed tightening cycle that is accelerated by the biggest rate hike in 22 years. On Wednesday, however, market indices began to soar on Wednesday when Fed Chairman Powell, one half hour after the Fed announced it 50 basis point raise, suggested that the Fed was not considering larger 75 basis point hikes during this tightening cycle. Traders interpreted this as taking the most hawkish scenario off the table. Up to that point, institutions were extremely bearish in their positioning, heavily weighted to puts on indexes and stocks, and also positioned for future rises in volatility in the markets. Right after Powell made his comments, investors started hedging and unwinding this positioning, and all the pro-cyclical elements entailed in this repositioning kicked in. By the end of the day, the technical pressures producing the squeeze had largely abated, setting the stage for a renewed, procyclical push downward the next day, as the negative aspects of the tightening cycle (and other economic headwinds) came to the fore. 


What these violent moves in the market are telling us is that while in the broader sense, this time is not different --the overall sine wave of the market is still that bubbles build and burst -- how the present bubble is bursting may be following a different dynamic than previous episodes. The changes since the great financial crisis-- the rise to dominance of passive trading through indexes and algorithmic trading through various quant strategies – reduced the friction in the markets as well as the value of picking individual companies. Now, the more recent explosion of option issuance, further accelerates market moves, and leads to unpredictable reversals that have to do with option positioning rather than fundamentals such as earnings, politics, or the state of the economy. 


The tail (the options and other derivatives markets) now wags the dog (the equities markets).



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