Game Theory or Schizophrenia?





I was always a fan of Game Theory and especially of its derivative game, The Prisoner’s Dilemma, since I’m an avowed believer in Zero Sum kinetics.

Game Theory If you don’t know what any of that means, you’ll have to decide whether to admit it, based on what your alter-ego will decide to do, knowing that your reward or punishment will be based on what you both decide, in the seclusion of the recesses of your warped mind(s). 

In the event you have more than one alter ego it gets just a bit more complex.

Welcome to my world.

Game theory is much easier when your alter ego is perfectly in sync with your true self. It’s also easier in totalitarian situations, because in such cases people are afraid to go counter to authority.  

Assuming that you possess some level of sanity and don’t have to take into consideration the needs of your alter ego, investing decisions, especially buy and sell ones, should be pretty easy. 

“Should be” is the operative phrase.  

I’ve long known that I’m incapable of selecting a good stock.

When I appeared on Bloomberg Rewind a couple of weeks ago, the guest panelist asked me the worst stock decision that I had made.  

My first thought was “why is this a**hole asking me that question?” Besides, how do you trust a guy who’s not trying to grow a mustache during MoVember, as the host, Matt Miller was bravely doing, without going on a 3 week vacation to do so.

It didn’t take me long, though, to dredge up a near quarter century decision to purchase shares of L.F. Rothschild, a one time venerated name in investment banking. That particular year, it had the distinction of being the largest percentage loser of any company on the NYSE.  

II may be a lot of things, but no one can accuse me of not learning from my mistakes.

At least the big ones.  

Instead, I stick to my list of “Old Reliables” and rarely venture outside that comfort zone.

When I do venture, my timing seems to be highly correlated to short term unwanted price movements.

About a month ago, just as earnings season was getting underway I bought shares in Green Mountain Coffee Roasters, Amazon and Netflix. Of those, I’d never owned Netflix before.  

I don’t know what made me purchase those. It was an uncharacteristic move for me to do so. 

What that triad had in common was great options premiums in advance of earnings. Maybe a little price momentum, as well. Amazon stood alone in that group by not having any black clouds hovering nearby.  

While Green Mountain delayed its earnings report by a couple of weeks, I had the opportunity to get three weeks of great premiums, but then came the news.

Green Mountain was already suffering from more doubts about its financials and Crazy Eddie like inventory issues.  

Prior to the live broadcast of Bloomberg Rewind the news came. Green Mountain’s disappointing earnings resulted in a $25 after hours decline. 

Of course, I had the lack of good sense to mention that I held shares on the program that evening, but I also mentioned that I didn’t buy into the Bernard Baruch axiom of cutting your losses at the 10% level.

Besides, with a cost basis of about $67, I’d already pocketed about $14 in premiums in that 3 week period. Still, Green Mountain opened at what would have been a 20% loss even when based on the net cost basis. I could feel Bernard rolling in his crypt. 

What I said on air was that I was going to stay the course and let emotions revert to the mean, just as prices do. The highs and the lows don’t last, except in the case of L.F. Rothschild and depression leading to suicide.  

My less cool and collected alter ego wanted to cut and run. 

I still have a hard time reconciling the fact that the investing cautious me, let’s call him “Louie”, is willing to have unprotected sex in a crack house, whereas the “no worry” investor me, “Ricardo”, would never think of doing such a thing.  

Then the realization hit.

It was Ricardo that made those uncharacteristic purchases and he now left me with the dilemma of what to do. Louis, on the other hand was smoking crack with the options premium money that Ricardo conjured up.  

The dilemma was created by not knowing what ultimate price would be exacted on any decision because there was yet another alter ego in the mix.

 This one was a nasty behemoth called the Stock Exchange.  

Great. Now I had to worry about what the macro-economic oriented market would do, as well as what that short sighted micro-economic Louie would want to do. Louis wanted to smoke his crack and have his stock profits, too.

Compound that with the fact that the market was beginning to react in an unprecedented way to rumors, news of possible news and news of real news.  

A purely rational person would have discounted the irrational market and made a decision purely on the remaining alter ego, being intimately aware of its thought processes. 

The investing cautious Louie would certainly look at the potential tax benefits of taking a strategic loss on Green Mountain shares and then take another long drag on that pipe, while taking care not to set his hair ablaze.  

The care free Ricardo would believe that tax consequences were irrelevant. In fact, the more taxes you had to pay, the better. That only meant that you had that much more in capital gains. 

“Laissez le bons temp rouler.”  

Did I mention that Ricardo actually had a Cajun alter ego, Ricardeux? 

Ricardo, for all of his subset personalities understood the concept of authoritarian rule. 

Khaddafi was on top of his game as long as he was ruthless. No one dared to question his decisions and he made them with impunity.  

Then he decided he had to get into the good graces of the West. 

We all know what happened then.  

So did Ricardo. 

As soon as his plane landed in Phoenix last Monday an additional lot of Green Mountain was purchased at $41.85 and weekly calls on that new lot were written at $42, while the original lot went unhedged. He assumed that Louie would be paralyzed by over analysis of the situation and would make no effort to counterbalance Ricardo.  

Louie was apoplectic, because Ricardo was right. And now, it was too late for Louie to do anything or to change his mind. There was no second deal to be made. 

At the very least Louie would have hedged the whole position, but that was now off the table, as well.  

In this game you have to be quick and ready to deal.

In the meantime, that nasty Stock Exchange decided to go into a mid-week funk, dropping about 3%.  

In the Prisoner Dilemma Game you also have to be ready for the unexpected. 

But the real unexpected was that even with walls of support crashing, Green Mountain climbed up to $51.

And so RIcardo and Louie were at odds again.  

Ricardo felt good about at least garnering some more options premium on the split holdings, not hedging the remainder and felt no remorse for foregoing paper profits.

Louis was unapologetic.  

He argued that the proceeds from selling the Green Mountain shares could have been plowed into the likes of Caterpillar, which was now trading below the $95 price at which shares were recently assigned. Besides the 2% weekly premium, theer were those tax advantages, too. 

And so, they were both right, at least for last week. Both had rational thought processes and understood the other’s positions and reasoning.  

But come Monday, the whole tug of war starts again. 

Both Louis and Ricardo will be aboard yet another plane when the Stock Market opens on Monday. In essence, they’ll be held hostage to the irrational movements of their macro ego.  

I wonder what would happen if I actually swallowed these green and white capsules?