I'm getting two major types of skepticism about my market bet on Wal-Mart v. Dukes, which I paraphrase as follows:
- "Your bet makes no sense because everyone already knows that the Supreme Court is going to reverse Dukes."
- "Your bet is too risky because there's a sizable chance the Supreme Court won't reverse Dukes."
I humbly suggest that the existence of the latter argument refutes the former.
That said, I have less confidence that I played this right than I did a few days ago. I think I underestimated the effect of the underlying variance of the options I purchased: it probably would have been sounder to purchase in-the-money options or longer-term options, even at the expense of somewhat muting the upside. (Transactions costs from the bid-ask spread mean that it doesn't make much sense to switch horses now.) I admit it's sometimes a little unnerving to see a $6000 fluctuation over the course of writing a blog post, and back up another thousand while I was writing this sentence.
In blackjack, if you're dealt an eleven and the dealer is showing a six, you double down. You don't double down because you're guaranteed to win: you might get a three, or the dealer might have a five as a hole card and end up with a 21. You double down because the odds are in your favor, and that's when you put your money on the table. Because of the random walk of stock prices, the noise from day-to-day movement of the stock price (which, unfortunately, dropped somewhat over the last week for reasons unrelated to the soundness of my hypothesis) may well overwhelm the signal from a Supreme Court decision. So I could be right ex ante and still lose money ex post; conversely, there's a chance that I'm wrong ex ante and still come out ahead ex post.
I'm not all that worried that I'm betting against the efficient market hypothesis. I've done something similar before. In February 2006, I blogged that proposed asbestos reform in Congress was very likely to fail after previously arguing that the Specter-Leahy bill was bad public policy. But the Associated Press reported that the bill was likely to pass; the reporter seemed unaware of a Senate procedural mechanism that would permit a minority to block the bill while simultaneously voting against a filibuster. In response to the AP story, asbestos-related stocks shot up in anticipation of a de facto bailout. I shorted those stocks, and closed out the position $14 thousand ahead a week later when Senator Ensign's point of order got the 41 votes needed to block the bill. And, as Alex Tabarrok reminded me, if I'm wrong and the efficient market hypothesis is correct, then my expected loss from the purchase is merely my transactions costs.