A startup as an options trade

20180120 Options startup

A trader spends inordinate amounts of the day looking at a screen, continually monitoring how assets react to events, seeking a signal amid a considerable amount of noise. At the same time, a successful trader needs to have the ability to correctly scale their risk. In a sense it doesn’t matter how often a trader is correct. The key point is that on average the return is positive. It is possible to be wrong most of the time, but provided a trader has leveraged sufficiently on winning traders, they can make a lot of money. Many of the skills which a trader learns are very transferable, even though, on the surface of it trading appears like a very specific skillset. In particular, I would argue that many of the decisions you have to make in a startup, could be thought of like (very long term) trading decisions, in particular when we are trying to quantify the risk versus reward of a startup decision.

 

I have been working independently for nearly 5 years. I started at the Thalesians, but in more recent years my focus has moved to a new startup Cuemacro, which I founded in the summer of 2016. One question that faces any startup is that of funding. In a sense, you can think of a startup, like an options trade. You are essentially long volatility. You are  long theta, continually paying premium on the hope of a larger payoff in the future. We have many questions. How can we fund this premium? How much “notional” to purchase? Should we buy options closer to the money or way out of the money? If you take the “organic” growth route, this involves trying to keep costs down as much as possible and only expand when you have sufficient net positive income. In a sense, it’s like being long heavily out-of-the-money options. The premium isn’t much, so there’s less bleed, but it might take a long time till the market moves to get this position to be in-the-money.

 

The approach is to seek outside funding. The cost is of course, giving away some element of equity in the startup. With external funding, you can expand quicker and grow more scale. From an options perspective, you are still long volatility, but the option is much closer to the money. It’s more likely to payout, but the cost of the options premium is higher, and the notional you are trading is also a lot bigger. The hope is of course that you get a payout much quicker and even if it doesn’t we have external funding to help us ride through storm.

 

So which is better? Each startup is in a different situation. In some cases, the “organic” approach will just take too long, and it is important to scale to make business viable and also to build an actual product. However, in other situations, you could stick to the “organic” way of the growing, if you feel that in the earlier stages you can begin to generate some (even modest) income, to pay back into the business. Trying to think of it as an options trade (at least for me) is a good way to get a handle on what can be a challenging problem, and to understand the risk versus rewards in a startup. Maybe the whole issue of funding will be turned on its head with ideas such as ICOs, which try to bypass the traditional VC route, changing the dynamics of growing a startup. Let us see!