Strategy Guide Note: There is no longer an interest rate in HSX so Dr Zeros has gone. The Twins are still around, but their influence is less. obvious. Also bear in mind that you have three potential deposits for you wealth, the movie market, the bond market and cash, each of which react differently to changes in the macroeconomic climate. If you’re serious about playing macroeconomics, you should consider your weighting in each of them (-Huy).

Given all of the hints and allegations about Interest rate hikes and their impacts, I thought it was time to write a column that I have mulling over some time now. Bear with me, this could get long, but will contain information that should be very useful to traders in making decisions in times of macroeconomic policy changes.

First, what is macroeconomics? Economists divide Economic theory into two broad categories: Microeconomics and Macroeconomics. Microeconomics is the economics of a specific market, explaining how supply and demand for widgets determines their prices. It looks at the behavior of businesses and consumers. It is also the area of economics that has the least disagreement among economists.

Macroeconomics, on the other hand, is the study of how all of the markets interact and how to make that interaction the most efficient and effective at achieving the macroeconomic goals of low inflation, low unemployment, and economic growth. It is the area of economics where there is the most disagreement – usually revolving around debates over whether the free market, for all its flaws, can better meet macroeconomic goals with or without government help, and if so, what kind of help.

In the real world, the macroeconomy is fueled by the money supply, which in the U.S. is under the control of the Federal Reserve Bank (usually called the Fed), and its chairman, Alan Greenspan. Their control is imperfect. Someone once compared managing the money supply to driving a car by looking through the rear view mirror. Mistakes get made, but overall the Fed has been doing an excellent job, by most economists standards, of money supply management for the last 20 years. We are currently living under the results of that good management, with the lowest levels of unemployment and inflation in 25 years. It is usually considered extremely difficult of getting both low at the same time.

The Fed has many ways it can control the money supply (monetizing or issuing national debt, changing the reserve rate, etc.), but the most common is through targeting interest rates. If the Fed fears inflation (which is too much money in the economy chasing after too few goods), and wants to tighten the money supply, it raise the discount rate at which it lends money to private banks. These banks then in turn raise the rates at which they lend money to their customers. If the Fed fears deflation (too little money), or think unemployment is too high, they lower the discount rate.

Keep in mind that entire books have been written about the Fed manages the money supply, and that the above is a thumbnail description that catches the main points, but misses a lot of nuances and exceptions.

This decision of whether to raise or lower interest rates has a profound impact on the economy as a whole. If interest rates go up, the cost of borrowing money has gone up. Since businesses borrow to make a lot of investments, this raises the costs of those investments and reduces the profitability of stocks in those businesses. If interest rates go down, the effect is reversed. Also, if interest rates go up, it raises the profitability of bond investments (buying a bond is really the same as loaning someone some money) as an alternative to stocks, so the stock market goes down and the bond market goes up.

Since the effects of interest rate changes are severe, investors watch for changes in interest rates very carefully. Wall Street watches Alan Greenspan religiously and analyzes everything he says for an indication of the future direction of interest rates. Greenspan knows this, and also knows that gradual changes are better for the economy than sudden shocks, so he usually telegraphs his intentions well in advance, so that when the change is actually announced, the effect on the market is less pronounced. Wall Street also watches the same indicators that Greenspan watches to determine if the economy is overheating or needs some fuel added to the fire such as the unemployment rate, productivity rate, and consumer and producer price indexes (which are all tabulated by the Bureau of Labor Statistics). This why good economic news often causes the Dow to take a downward dip. High inflation figures might be an indication that the Fed thinks the economy is getting out of control and might raise interest rates, which spooks the stock market and spurs the bond market in anticipation of these changes.

Now, what does all this have to do with HSX? HSX has its own macroeconomy, money supply, and stock and bond markets, and they have their own macroeconomic policy decisions, which I am sure they have always made, but have only recently began talking about publicly. HSX implements macroeconomic policy for two reason, I believe.

1) Since HSX is a market simulation, they try to simulate some of the same things that happen in the real world. Dr. Zeros new monthly pronouncements on interest rates are intended to be a direct parallel with the Fed’s Open Market Committee meeting where interest rate decisions are made an announced. Max’s hints of interest rate changes have a parallel in Greenspan’s cryptic cautionary advice to the market. I had a brief e-mail communication with Max where he implied that Dr. Zeros’ monthly pronouncements about the HSX economy will become a regular event. Get used to it.

2) HSX also adjusts the macroeconomy because it has to. The real stock market doesn’t create money, it just helps exchange it. For every stock bought low, their is a stock sold low – for every stock sold high, there is a stock bought high. It keeps going up because new money, from wealthier citizens and foreign countries keeps coming in. There is no such parity of exchange on HSX. Money is created from scratch every time a new account signs on. It is also created when a stock is adjusted upward after a good opening weekend, when a stock is delisted above its selling price, when a bond pays out interest or adjusts upward, when Max hands out 10k HBucks for getting a trivia question correct on WBS, and when the Twins go on a buying spree.

If HSX did nothing to control their macroeconomy, we would be in inflationary hell. All stocks and bonds would be grossly overpriced and we would have no fun, since all we would be doing is betting where the money would go next, instead of betting on the performance of films. The game would collapse and all of us would have to find another addiction.

So, since HSX has good reasons to have some macroeconomic fun with the market, how do they do it? I have observed two primary tools:

1) Volatility adjustment: HSX can control the amount the price of a stock changes when a unit is bought. They usually don’t announce these changes, but they have announced them enough to know that they do it. Theoretically, I suppose they could have different volatility settings for buys than they do for sells, but I don’t know if this is the case. Adjusting the volatility is a powerful tool to use when a major “event” is causing a money supply problem, such as when HSX is publicized in a major news publication (I myself logged on when Entertainment Weekly gave them a write up), or when a major delist threatens to flood the market. During times like this, HSX can lower the volatility to curb the inflationary effects. When TITAN, TMRND, and MSHNT all offered serious arbitrage opportunities, HSX changed volatility across the board to eliminate the price gaps. This became evident by the huge price swings and chucks which occurred. The price gap did close, but every other stock plummeted in price.

2)Action by the Twins: This has only been acknowledged to have happened twice, but I suspect it takes place more often, based on the behavior of certain stocks (ROBOT, for instance). It looks like that when HSX wishes to undertake a major Twins buying or selling operation, they will make a change in the money market interest rate first. HSX implies that the interest rate change causes the Twins action, but I strongly suspect they are two separate decisions, since writing the code for an automatic change would be a major pain, and we know that the twins can act independently of any interest rate change. So, when Dr. Zeros changes interest rates, this is symbolic that the twins are going to start something. This has only happened once so far, and the Twins action was astounding, and probably excessive. But be very careful on drawing conclusions based on one data point. It is quite possible that any future interest rate change would signal a much smaller impact, and perhaps be limited to the bond market, or even a few overpriced stocks.

So, how do you use this knowledge to your advantage? If Dr. Zeros announces and interest rate change, I would strongly suggest running over to his Board on Ticker Talk and see what Twins buying action is announced. The last time, they bought 50 billion shares (I believe), seemingly indiscriminately within the stock market (I think the Bond market was ignored, but I could be wrong.) The greatest percentage changes were in the lower priced stocks, and the spree continued for several days. I would look at the amount of the buying spree and look where it is concentrated. If it seems significant, make your move as early as possible. If the twins say they are selling bonds, get the hell out of the bond market and into the stock market, ASAP, for instance.

Also, keep an eye on the learning curve of traders. In the real world, if Greenspan sneezes the market drops 50 points. But Greenspan has a track record and real money is at stake. It is very much unclear how traders will respond to hints from Max and Dr. Zeros. I would suspect that people won’t change their behavior much for now, but if hints are followed by severe enough actions, people will start to pay attention.

What are my thoughts on HSX’s monetary policies? I am cautious. I know that the Fed has a long track record, expert staff, and a history of making good decisions. I have this nagging fear that Dr. Zeros might send the market into a tailspin just for s***s and giggles, or because he thinks having the HSX follow a Wall Street tailspin would make a nice media angle for a new story in the WSJ. I am probably paranoid, but it would help if I knew what criteria HSX was using to decide if the market was over or under priced. What is an overpriced bond if the Oscar winner is guaranteed to offer a 100% return the next day? Theoretically, if KWINS were guaranteed to win, she would be a good buy if she were priced at $1 billion per bond (this is why I agree with The Trades’ The Analyst and think their Oscar bond scheme is goofy.) For all of traders’ talk a few weeks ago that stocks were overpriced, WDDNG was a windfall and SPHER and BORRW were priced only slightly above their actually box office.

My advice to HSX is to tread cautiously and when it comes to making macroeconomic decisions, “when in doubt, don’t”.

Laissez faireishly yours,

Tom Miller

Economics is based assumptions, approximations of how the big bad world really works. Some of them are sensible, some of them. less so. Perfect competition, for instance, that one always cracks me up. Perhaps the hardest assumption to swallow is the concept of the rational economic man, the idea that people are strictly logical, centered on a clearly defined goal and free from the unsteady influence of emotion or irrationality. Does this sound like the sort of person you see in the mirror each morning?

The truth is the rational economic man assumption is a poor indicator of human behavior. It doesn’t predict how the big bad world really works and it sure doesn’t apply to HSX. But fear not! As a recent-ish article in The Economist (18 December 1999) shows, economists aren’t letting man’s fundamental irrationality get in their way.

Let’s take a look at some of the attempt to explain irrational behavior and see how they apply to HSX (quotes taken directly from The Economist):
Anchoring.
“People are often overly influenced by outside suggestion. People can be influenced even when they know that the suggestion is not being made by someone who is better informed. ” So maybe all those shills on Ticker Talk work, after all? Also, possibly a pointed reference directed at the various HSX columnists. Some columnists are better than others, that goes without saying. But perhaps it doesn’t matter how good or bad they are, people will follow them anyway. To my mind, though, this is Max through and through. We all know he talks crap but we still follow him.

Availability Heurism.
“People focus excessive attention on a particular fact or event, rather than the big picture, simply because it is more visible or fresher in their mind. ” And the big chant on Ticker Talk goes, ‘one factor analysis’. I’ve heard all the following – I’ve even said a few – “Martin Lawrence can’t open” (Blue Streak), “Never bet against animals in horror films” (Bats), “Too similar to Mercury Rising” (The Sixth Sense), “Most of us would rather watch Schwarzenegger or Brosnan save the world” (Toys Story 2), and my personal favorite, “It’ll never do those numbers on 1,000 screens” (The Blair Witch Project).
Cognitive Disorder.
“Holding a belief plainly at odds with the evidence, usually because the belief has been held and cherished for a long time. Psychiatrists sometimes call this ‘denial’. ” This generally happens when a stock has been trading at an unrealistically high level for some time. The stock suddenly drops sharply then stabilizes. It’s all too easy to think that the stock will ‘naturally’ return to its previous level, rather than examine whatever new evidence is out there. How many of us have bought back in, waiting for the upturn, only to suffer big losses when the stock drops again? Stocks prone to this kind of behavior included The Green Mile and Man in the Moon. In fact, virtually all of last December’s releases.
Compartmentalization.
Making “choices about things in one particular mental compartment without taking account of the implications for things in other compartments”. When box office news comes in, movie stocks move like a rocket. However, warrants and bonds don’t. The next time some unexpected box office news comes in, check the bond charts, and cash in before the herd.
Hindsight Bias.
“Once something happens, [people] overestimate the extent to which they could have predicted it. Closely related to this is memory bias: when something happens people often persuade themselves that they actually predicted it, even when they didn’t”. This sounds terribly familiar. You briefly making a trade, then reject it for whatever reason. A couple of days later, the stocks moves, and you find yourself counting the profit you would have made. Suddenly, you have an awful lot more confidence in your ability to predict the market. Of course, what you’ve forgotten is all the ideas you rejected that would have lost you a packet.
Magical Thinking.
“Attributing to one’s own actions something which had nothing to do with them, and thus assuming that one has a greater influence over events than is actually the case. For instance, an investor who luckily buys a share that goes on to beat the market may become convinced that he is a skilful investor rather than merely a fortunate one. He may also fall prey to quasi-magical thinking – behaving as if he believes his thoughts can influence events. ” Again, columnists and Ticker Talk posters everywhere, time to bow our heads in recognition.
Representative Heurism.
“A tendency to treat events as representative of some well-known class or pattern, This gives people a sense of familiarity with an event and thus confidence that they have accurately diagnosed it. This can lead people to ‘see’ patterns in data even where there are none.” Oh gawd, that’s me.

I have the horrible feeling that the vast majority of these apply to, well, to me at least. If you can honestly say that you’ve escaped them all, I doff my hat to you.

-Huy

 The next generation

After a long, long time in the doghouse, the fund market has sprung back to life, with HSX IPOing new funds like they’re going out of fashion. But, as always, there’s a catch. These are funds, Jim, but not as we know them. How do these new-style funds stack up – and are they worth investing in?

Here’s what Darth Mac has to say about the new funds: “I’ve instituted changes to funds, mainly with a H$20m starting fund and a 1:1,000,000 price/net worth conversion ratio. These changes were made because I see funds as long term investment vehicles having diversified portfolios within the fund theme, instead of as short term profit runs. I want to see funds act as educational tools using different investment strategies and exposing “hidden” securities to traders at large. More like funds in the real world.” Translation: the old-style fund were making too much money and delisting too quickly, which may have had a distorting effect on the market. HSX was looking for a way to slow the funds down.

Boy, did they find it.

Take it from somebody who knows – these new-style funds are tough.

How’d they do?The table below gives you an indication of how the funds have been doing.

The table below gives you an indication of how the funds have been doing.

@ Up to and as at 11/20/00.

* IPOed after start of season.

# IPOed after beginning of October.

OK, first a word about the table. The choice of October as the month and November 20 as the cut-off date for the season to date are completely random. They just happened to be the figures I had available. There is no other significance to them. They were not chosen to flatter any particular fund. Had I chosen different dates and/or months, the results would equally be different. How different? I don’t know, I haven’t cracked the numbers. There have been some slight jockeying for position. But I’m betting that the overall trends would have been pretty much the same – and that’s what I’m paying attention to. In fact, arguably these number are slightly biased, because they include the GRNCH/RATS2 adjust. If I’d looked at the numbers just a few days earlier, they would have been very different.)

With that disclaimer out of the way, what can we tell? First off, that performances for the month of October are almost universally better than for the season to date. The reason for this is insipid market conditions during pretty much the whole of September, which dragged the season to date figures down. Which brings us to another point: collectively, the funds are pretty good indicator of market conditions. If they’re all showing gains, the bulls are in full force and effect. If they’re all showing losses, duck and cover.

The other thing to notice is that not all funds have performed equally. Rather than rate them individually, I’m going to place them into four broad categories:

High fliersAre (in alphabetical order) BRITS, COMIC and ZOO. Little to choose between ZOO and BRITS (and on a personal note, a big thanks to Txredd, who has been the alternate fund manager for BRITS during my absences). ZOO didn’t play GRNCH, which is why its performance looks worse, but in the long run there isn’t much in it. A word about COMIC. Now you could argue that being the first new-style fund was an advantage, that the theme allows them to trade in lots of volatile stocks and that having four fund managers give them the chance to tag-team trade, which is probably the most efficient way of doing things. But still, wow. $45m in a new-style fund is an impressive feat. Let nothing detract from that. However, their performance in both the season to date and in October wasn’t quite so stellar. Either they’re running low on enthusiasm or (more likely) their running low on decent stocks to invest in. As the fund increases, returns drop. This is going to happen to all the funds in the same way as it happens to all ports, only faster since funds are already restricted in what they can invest in. If anything, I guess the fact that all the fund managers involved are HSX veterans. Big shock there: experience helps. Except there are funds out there run by vets which haven’t done so well. So experience helps, but it isn’t the be-all and end-and.

Are (in alphabetical order) BRITS, COMIC and ZOO. Little to choose between ZOO and BRITS (and on a personal note, a big thanks to Txredd, who has been the alternate fund manager for BRITS during my absences). ZOO didn’t play GRNCH, which is why its performance looks worse, but in the long run there isn’t much in it. A word about COMIC. Now you could argue that being the first new-style fund was an advantage, that the theme allows them to trade in lots of volatile stocks and that having four fund managers give them the chance to tag-team trade, which is probably the most efficient way of doing things. But still, wow. $45m in a new-style fund is an impressive feat. Let nothing detract from that. However, their performance in both the season to date and in October wasn’t quite so stellar. Either they’re running low on enthusiasm or (more likely) their running low on decent stocks to invest in. As the fund increases, returns drop. This is going to happen to all the funds in the same way as it happens to all ports, only faster since funds are already restricted in what they can invest in. If anything, I guess the fact that all the fund managers involved are HSX veterans. Big shock there: experience helps. Except there are funds out there run by vets which haven’t done so well. So experience helps, but it isn’t the be-all and end-and.Worth a lookAre (in alphabetical order) AUSIE, BOOKS, ELVES, HERO, SNL and SQUEL. A real mixed bag here, but respectable performances all. ELVES and HERO both suffer from what look to be extremely constrictive themes. The same may well apply to SNL. Just how many films can all those ex-SNLers make? On second thoughts, scrap that. The BOOKS was initially doing very well, tailed off a little and is now coming on strong again. It’s already been through a change of primary fund manager, which may account for the mid-season dip. SQUEL started off strong but has struggled slightly to keep up the same pace. I don’t know anything about the guys running the AUSIE fund, but they seem to be doing a good job.

Are (in alphabetical order) AUSIE, BOOKS, ELVES, HERO, SNL and SQUEL. A real mixed bag here, but respectable performances all. ELVES and HERO both suffer from what look to be extremely constrictive themes. The same may well apply to SNL. Just how many films can all those ex-SNLers make? On second thoughts, scrap that. The BOOKS was initially doing very well, tailed off a little and is now coming on strong again. It’s already been through a change of primary fund manager, which may account for the mid-season dip. SQUEL started off strong but has struggled slightly to keep up the same pace. I don’t know anything about the guys running the AUSIE fund, but they seem to be doing a good job.Too soon to sayAre DJAVU, KIDS, CAINE and AWARD. CAINE and AWARD fall completely outside October, and therefore my comparison. DJAVU and KIDS fall within it, but only just. This has the effect of slightly dampening their performance. KIDS is doing very well at the moment, off the back of the GRNCH/RATS2 adjust. But hey, even if you get the opportunity, you still have to call them right. So far, none of the other funds have set the market alight, but it often takes a little time for funds to settle. Don’t write them off just yet.

Are DJAVU, KIDS, CAINE and AWARD. CAINE and AWARD fall completely outside October, and therefore my comparison. DJAVU and KIDS fall within it, but only just. This has the effect of slightly dampening their performance. KIDS is doing very well at the moment, off the back of the GRNCH/RATS2 adjust. But hey, even if you get the opportunity, you still have to call them right. So far, none of the other funds have set the market alight, but it often takes a little time for funds to settle. Don’t write them off just yet.To avoidIs CANUK. What went wrong? The theme is on similar lines to BRITS and there’s theoretical reason why it couldn’t do as well, bearing in mind just how many Hollywood productions are now filmed in Canada to cut costs (I think both these funds have the edge over AUSIE in terms of opportunities). But somewhere along the lines, it’s all gone horribly wrong. The absolute minimum a fund should be able to do is to retain its value. Six weeks on, CANUK is still trading below it IPO price. Hopefully the fund managers are learning from their mistakes and we’ll see CANUK’s performance gradually improve. Or maybe they should speak to Jimmy.

Is CANUK. What went wrong? The theme is on similar lines to BRITS and there’s theoretical reason why it couldn’t do as well, bearing in mind just how many Hollywood productions are now filmed in Canada to cut costs (I think both these funds have the edge over AUSIE in terms of opportunities). But somewhere along the lines, it’s all gone horribly wrong. The absolute minimum a fund should be able to do is to retain its value. Six weeks on, CANUK is still trading below it IPO price. Hopefully the fund managers are learning from their mistakes and we’ll see CANUK’s performance gradually improve. Or maybe they should speak to Jimmy.Wrapping upEverything above is all well and good, but I’m guessing what you really want to know is; are they worth investing in? And the answer is. maybe. The rule of thumb generally tossed about is that an ROI of one or over is good. And yes, it’s true that a fund can hit an ROI of over one. But I’m still not sure they can do it for sustained periods of time. So none of them are going to earn you the screaming fortune that funds of yore promised. That was the idea. However, a lot of the funds are still solid earners. The kind of investments you can purchase and forget about as they work to earn you money. For a lot of traders – especially those who don’t want to be wed to HSX every waking day – that’s got to be worth something.

Everything above is all well and good, but I’m guessing what you really want to know is; are they worth investing in? And the answer is. maybe. The rule of thumb generally tossed about is that an ROI of one or over is good. And yes, it’s true that a fund can hit an ROI of over one. But I’m still not sure they can do it for sustained periods of time. So none of them are going to earn you the screaming fortune that funds of yore promised. That was the idea. However, a lot of the funds are still solid earners. The kind of investments you can purchase and forget about as they work to earn you money. For a lot of traders – especially those who don’t want to be wed to HSX every waking day – that’s got to be worth something.-Huy

There’s been lots of discussion lately about the prospects of staged-release movies. With last weekend’s releases all being of the platformed variety, all sorts of theories were being thrown around Ticker Talk about how to predict the box office for a movie about to go wide. These ranged from simple proportionality (“the movie made $1M on 100 screens last weekend, so it will make $10M on 1000 screens this weekend”) to fairly sophisticated rules of thumb (“with your typical expansion, screen averages drop by about 70%”). Hopefully, this column will be of some use in between the myriad alternatives.

To start, let’s quickly debunk that first method. The assumption behind the proportionality theory is that the amount of money made per theater does not change when the number of theaters increases. However, looking at most of the platformed movies since the latter half of 1998, I’ve seen only two instances of films that did not lose any per screen average (PSA) while significantly expanding. The first is A Simple Plan, which had a $5K PSA on 80 screens but a $5.2K PSA the next week on 660 screens (thanks to Ramon for pointing this one out). The second is Shakespeare in Love, which saw a $4.2K PSA in 833 theaters expand to a $4.6K PSA in 1956 theaters (this boost is entirely attributable to the announcement of Oscar nominations).

And that’s it. Just those two solitary exceptions (I looked at over 15). There are many reasons why this should be the case. First off, there will always be the natural dropoff of business at those theaters who are running the film for the second week (depending, as it always does, on the size of the opening weekend rush and the quality of word-of-mouth). And of course, we know that the movie business is not immune to the economic laws of competition – a theater enjoying a local monopoly on a film obviously will draw more patrons than one that has to contend with several others.

Looking beyond these obvious reasons, though, one finds a number of subtler reasons that contribute to PSA decline. For one, many of these platformed releases are critical and artistic darlings, which might draw a lot better among New York and Los Angeles audiences than they do in suburban multiplexes. Another reason is that theaters that host the only run of a movie in a given city are often large, and run the movie on several screens, factors which aren’t duplicated when the film hits the ‘burbs.

So how do we use these factors to predict PSA dropoffs? Well, clearly the biggest factor is the size of the expansion. The three films that I looked at that made the biggest leap from limited release into wide release (percentage-wise) were SNOWF, LIVLO, and CIVIL. CIVIL went from $35.4K on two screens to $8.4K on 1802, a dropoff of 76% in PSA, SNOWF went from $16.3K on three screens to $3.4K on 1150 screens, a dropoff of 79%, and LIVLO had an 81% drop from $21.2K on 8 screens to $4.0K on 1086 screens. These three were three of only four films that registered a PSA drop of over 70% (the third being Election, which had a 78% drop when it went from 14 screens to 827; I’m not quite sure which factors to attribute that one to).

On the other side of the ledger, we have films that take their expansions piecemeal, like CIDER ($4.7K PSA on 332 screens expanding to $3.8K on 816); ELIZA ($9.1K on 144 expanding to $6.6K on 516); and AMBEA ($13.8K on 429 expanding to $11.6K on 706). In fact, for films with smallish expansions like these, a good rule of thumb to use is to treat them exactly like regular films returning for their second week. For example, with AMBEA, we see that its first weekend on 429 screens made about $6M. We know that, ignoring the expansion for the time being, the next weekend would be about $5M, since the word of mouth was incredible. Since the expansion to 706 screens can’t possibly decrease that absolute figure, we can use the $5M figure as a minimum estimate for the next weekend, tack on a tad extra for the additional 300 screens, and come up with a relatively good figure.

There are a couple other mitigating factors that might provide for less of a PSA dropoff. First is advertising – a film that gets virtually no advertising until the very week before release will suffer less of a dropoff than one that had been advertising while the film was limited. Secondly, one should also consider how long in limited release the film had been before going wide. If the movie was limited for just one week, much of its limited PSA would have been inflated by the opening weekend rush. On the other hand, if it had been stuck in a limited pattern for a while, it would have started to exhaust the local audience; the wide release thus gives it an opportunity to tap new markets. For example, three of our four big PSA drops (CIVIL, SNOWF, ELECT, LIVLO) had all been in limited release for only one week before going wide (SNOWF was two weeks), while the two movies that gained in PSA had been stuck at the same level of release for some time (ASMPL for 6 weeks, SHKSP for 5+).

Generally, then, I think a good way to go about figuring out expansions is to first figure out just how big an expansion it is. There are small expansions (say, going from 200 screens to 600 screens), medium expansions (from 30 to 200, or from 200 to 1400), and large (from 20 to >1000). Each type of expansion has a “rule of thumb” percentage dropoff (about 30% for small, 50% for medium, 65% for large) which you can then tweak using the criteria laid out above (artsy vs. mainstream, word of mouth, advertising, etc.)

So what does this all mean for LHURR and GINTR? LHURR took in a $35K PSA on 11 screens, and expanded to a $15.2K PSA on 160 screens last weekend. Ads have been running for a while, but it doesn’t seem overly geared towards the high-brow audience, and word of mouth is fairly good. Screens for this weekend are rumored to be around 1800. The closest comparison I can see is THINR, which had a 65% PSA drop when it went from 61 screens to 1528. Percentagewise, this is a bigger expansion than LHURR’s, and THINR is decidedly less mainstream, so we should whittle that 65% figure down a tad. If you figure a 55% drop in PSA for LHURR, we get around $6.8K per screen. On 1800 screens, that’s about $12M. Don’t forget to add in the previous box office of around $4M, and one gets an approximate adjust of $39.

GINTR took in $17K per screen on 9 screens last weekend. While it also doesn’t seem to be too much for mainstream audiences to handle, and its per screen take has been going up each weekend for three weekends, signalling some fairly good buzz, a leap from 9 screens to over 1000 can definitely take a huge bite out of your PSA. There is a hard bottom, though, at an 80% dropoff, so we can pretty much assume a $3.4K screen average for this weekend at the very least. Since ads have been plentiful (unlike, say, SNOWF or LIVLO), you probably want to bump that figure up somewhat, depending on how effective you think the advertising has been. 

Good luck, and have fun storming the castle!

Given the lower than expected (at least by me) drop offs to DVADV and IKNOW, plus their closer delist dates, both stocks present an excellent arbitrage opportunity when HSX comes back online – between 1.5% and 2.0% per day.

Given the presence of this most excellent arb, I revise my stock recommendations as follows (in order):

1) BOOGI (only if you can get in early at a price below $20. This should rise fast) 2) MANWH (still dirt cheap and offering an estimated return of 20% per day) 3) MADCI (An adjustment to at least the 20’s, in my estimate) 4) DVADV (slightly better than IKNOW) 5) IKNOW 6) STARS

STARS has dropped a bit in my rankings. This is partly due to the arb stocks available, also because I have thought a bit more about STARS. I still think it will have a $30-$35 million weekend, but it is unlikely it will delist much over $90. This is largely due to the high screen count, and heavy competition coming up. Bluckbusters with high screen counts usually have a very high drop off, since its easier to find a showing which fits a filmgoers schedule and fewer audience members are turned away due to sell outs. Mission Impossible and Lost World, both examples of very high screen counts, both did way below the average 3x 1st weekend multiplier. There is also some heavy competition heading its way in the form of JACKL, ALIEN and FLUBR.

A lot of traders will realize this, and there will be a massive selloff when STARS unhalts, cutting into the likely profit margins. I still think this stock will be profitable, but it probably won’t be as profitable as the other opportunities listed, and offers a much higher risk. In other words, the stock is likely to have a high opportunity cost. However, if you are quite sure STARS will have a weekend in excess of $37, it should be adjusted high enough to make it a better deal than the others. I am skeptical of it reaching such lofty heights. AIRFO set the R rated opening weekend record this summer, and STARS is unlikely to do much better than that.

Tom Miller

 Strategy Guide Note: Actually, the concept of risk arbitrage is very similar to expected value. Read both columns and decide for yourself (-Huy).

I. What is risk arbitrage?

On Wall Street, there are two types of arbitrage. The first type, which is commonly referred to as “classic arbitrage,” occurs when an instrument is incorrectly priced, causing a risk-free profit opportunity. For example, if a real life stock is trading at 60, and a call option with a strike price of 40 is trading at 15, a person could make a risk free profit by buying the options and shorting the stock until the prices corrected. This is the type of arbitrage that people refer to in HSX when they say that a stock is “arb.” If a movie has already grossed 40 million a week before delist, and the stock is trading at 38, everybody and their mother will post on TT that the stock is arb. (For more on classic arbitrage, see Tom Miller’s Cinemeconomists definitions).

Risk arbitrage takes classic arbitrage to the next level. A practitioner of risk arbitrage will take a situation with a finite number of outcomes, predict the likelihood of each outcome, and invest accordingly. For example, a risk arbitrageur in real life may be faced with a company’s vote on a merger. In this hypothetical, if the merger vote passes, the price of the stock will go up by 5 dollars per share. If the shareholders reject the merger, the price will go down by the same 5 dollars. The risk arbitrageur must determine the likelihood of each outcome and then decide whether to buy or short.

Risk arbitrage is a very important field on Wall Street. Robert Rubin ran the Risk Arbitrage desk at Goldman Sachs before he become CEO at Goldman and later, US Secretary of the Treasury.

II. Risk Arbitrage on the HSX

Most of HSX does not lend itself to risk arbitrage. The principles underlying predicting weekend openers are similar, but risk arbitrage focuses primarily on a finite number of specific outcomes, rather than open-ended speculation. Nonetheless, there are a few types of situations that lend themselves to risk arbitrage.

We had an interesting risk arbitrage opportunity in December. FANTA was getting ready to open, and we still had not heard from HSX about how they were going to calculate FANTA’s box office. There were three primary outcomes:

a. FANTA would not adjust, and would delist 12 weeks after it started on IMAX;

b. FANTA would adjust when it went wide, and would not include IMAX box office; or

c. FANTA would adjust when it went wide, and would include IMAX box office.

Under scenario (a), FANTA was a nuclear short, under (b) a close call but probably a hold, and under (c) a nice long-term hold for large ports. This scenario is not a perfect example, because even if you knew which way HSX would decide, you still had to predict the opening weekend determine the ROI.

(BTW, I believe that HSX made the wrong decision on FANTA, but that’s a subject for another day).

Some of the best situations for risk arbitrage on HSX come from similar rule interpretations. In addition, sometimes there is a situation where a studio has to make a decision, and there can be risk arbitrage opportunities there as well. The most common form of risk arbitrage, however, is in calculating bond adjustments.

III. Risk Arbitrage and Claire Danes

Two weeks ago, Claire Danes was on the calendar for adjustment for her performance in MONON. There were two possibilities: Either she would adjust, or she wouldn’t. (There was also a sub-possibility, as we shall see). This is the perfect scenario to apply risk arbitrage principles.

For the sake of simplicity in this example, I’m going to use round numbers and assume that ROI and commissions are not a factor. Also, it is important to note that the analysis I use contains my own presumptions. You may have totally different ideas about the likelihood of the CDANE adjust. Mileage may vary.

CDANE was trading at 1617. Our own DP Roberts calculated that CDANE would NOT adjust. AB Bond calculated that CDANE WOULD adjust, to 917. DP and AB posted their views on the bond board, and agreed to disagree.

To decide what to do based on the principles of risk arbitrage, a trader must ask two questions:

1) What is the relative likelihood that either DP or AB will be correct; and

2) What would be the investment result of either selection.

Looking at the first question, DP and AB agree most of the time. They are both very good at calculating bond adjustments, except that DP is better. (Actually, DP is good at everything – the guy is a force.). This is no slight on AB, who is a terrific trader and does an excellent job on bonds. In any case, I estimate that on the occasions when they disagree, DP is correct 80% of the time.

(Now an important disclaimer: DP himself does not believe that he is correct 80% of the time in which he and AB disagree. He actually proposed that I use a 50% number. Nonetheless, the 80% figure is more illustrative of how risk arbitrage works, so I will use it.)

Looking at the second question, let us assume that the trader shorts CDANE at 1619. If AB is right, CDANE will adjust down to 919, for a nice profit of 700. I have previously assigned this possibility a 20% likelihood.

If DP is right, then CDANE does not adjust. The investment result of the short is that lots of people cover their CDANE shorts and the price goes up. It is 50-50 whether I’ll be able to be on-line at the time of the adjust. (This is the sub-possibility referred to earlier). If I’m on-line at the time, I’ll lose 70 from other people covering and chuckage. If I’m not on-line, I’ll lose 140. So that means out of the 80% when DP is right, 40% would yield a loss of 70, and 40% would yield a loss of 140.

According to this analysis, if I shorted CDANE at 1619, there would be

a) a 20% chance of gaining 700;

b) a 40% chance of losing 70; and

c) a 40% chance of losing 140.

If you do the math, the short comes out to a prospective gain of 56. A risk arbitrageur that wasn’t concerned about ROI or commissions would always short CDANE in this scenario. I know I did.

CDANE did adjust to 919. AB was correct.

IV. Covering your short

Let’s say that everyone shorts CDANE, and the price starts to drop. At a certain point, it no longer makes sense to hold. You would want to cover when the prospective 20% gain was no greater than the 80% loss You can do the math, but I would have covered if CDANE had dropped to 1339. At 1339, there would be a 20% chance of gaining 420, a 40% chance of losing 70, and a 40% chance of losing 140. At this point, the investment is neutral.

V. Conclusion

There aren’t that many pure risk arbitrage opportunities in HSX. Nonetheless, the skills utilized in risk arbitrage are useful to other areas, such as portfolio construction and day-trading. Most of all, there are very few things more satisfying in HSX than working out a risk arbitrage scenario correctly.

I was mulling over various concept column ideas, including risk, when I got an e-mail from Jim Lewis, a fellow believer in the use of finance and economic principals in playing HSX. Jim made the following statement and suggested I write about risk.

“We all got clobbered last weekend on MADCI and STARS, right? But most of us made out like bandits on IKNOW and DVADV. Unfortunately, I was full up (50K) on MADCI and only had about 30K each of the two arbs. Why? MADCI looked way more underpriced and promised a higher return per day. This makes good sense as far as I took it. What I forgot was basic finance. When valuing the cash flows associated with these investments, I didn’t account for the much higher risk of holding an opener (MADCI) through the weekend.”

Jim raises an excellent point. I did mention in my column last week that traders should invest in the arb stocks before STARS. I recommended this not because I thought STARS wouldn’t make money (I thought it would make more money than the arb stocks), but because there was greater risk associated with it. However, I didn’t explain the risk factor very well, an omission which I will now correct.

Most people are risk averse – they don’t like taking unnecessary chances with their lives or their money, unless there is a commensurate benefit (skydiving is very risky, but skydivers find it fun – a benefit). Therefore, anyone who wishes to sell you a risky investment opportunity has to offer you a greater benefit in order to get you to buy. In finance, the safest place to invest your money is usually considered to be short term U.S. Treasury Bills (which are shares of the vast Reag-, err… U.S. national debt). T-bills, as they are called, offer a “real” (meaning: “accounting for inflation”) return of around 5%. (I might be a little bit off here, I haven’t checked prices for a while). The short term T-bill rate is used as a benchmark for other financial investments.

The difference in the rates of return offered between T-bills and other investments is referred to as the “risk premium” – the higher rate needed to make up for risk. The riskier the investment – the greater the rate of return. For instance, 30-year T-bills offer a better return than short term T-bills because there is a greater risk of inflation in the long term. The (real) stock market offers an even greater return due to risk (stocks have grown at a “real” rate of about 10-12% a year since the beginning of the century, including the Great Depression, but their volatility is much higher – witness the wall street mess two weeks ago), and junk bonds, in their heyday, offered an even greater return, often in the high teens and twenties, since the risk of default was even higher.

So, how does this apply to HSX? Assuming you are risk averse, you should require a higher rate of return for riskier stocks, such as openers, when comparing them to safer stocks, such as arbitrage stocks like DVADV was last week. How much greater of a return? It really depends on you and the confidence you have in a stock. For instance, I didn’t have a whole lot of confidence in my prediction for STARS, so I explicitly used a 3x risk premium, requiring that STARS offer me three times the rate of return as the arbitrage alternatives before I would prefer STARS to DVADV or IKNOW, which were very safe. I used a 2x risk premium for MADCI, since I (incorrectly) had more confidence in my prediction. Since MADCI, even with the risk premium adjustment, had a better predicted return than the arb stocks, and STARS had a worse return, this made MADCI a better buy than DVADV and IKNOW, and STARS a worse buy. I ended up being right about STARS but wrong about MADCI. Still, if I had ignored risk, I would have lost 400k more on STARS.

One thing to keep in mind is that a risk adjustment assumes you don’t like risk. However, many people deliberately engage in high risk behavior that has a long term negative financial payoff, such as playing the lottery, because to them the excitement factor overcomes the risk. If your goal is to have fun, and you find waiting for the preliminary Saturday numbers exhilarating, not nerve-wracking, then you might want to ignore risk, or even prefer riskier stocks to safe arb stocks. Just remember that your portfolio will probably suffer for it.

Tom Miller

There is an inherent problem on HSX created by time. Return rates are generally so high, that any return less than 1% per day is generally sneered at by traders (even large accounts generally do better than that), and return rates of around 1% are usually only considered if the investment is very safe, such as arbitrage. Therefore, when a stock adjusts it needs to offer about a 24% (due to the effects of compounding) return over the next three weeks to be worth holding for the long haul. (Most traders don’t do the math, but they follow instincts and hunches which closely approximate the behavior of someone who has done the math.)

Stocks receive a 2.9x adjustment since that is fairly close to the multiplier that the average movie receives. Therefore, on average, stocks will delist at the same price at which they are adjusted, and in about half the cases, will delist at less than their adjusted price. Even those stocks which have a higher delist multiplier usually don’t make the 24% over 3 weeks profit margin criteria. Hence, adjusted stocks are almost always not worth holding and everyone sells.

So, what is a stock actually worth post-adjustment? If one assumes that any return of less than 24% over three weeks is unacceptable, a stock which is expected to delist at its adjusted price is actually worth 81% (1/1.24) of its adjusted price. (MNIRN fell worse than this because traders anticipate a lower than average multiplier due to the large number of screens and poor word of mouth).

So, why not just adjust opening stocks to a 2.4 multiplier, which would be commensurate with a 24% profit margin? Well, HSX used to do this (2.3x actually), and everyone complained since there was no reason to hold openers, as very few stocks ever reached this threshhold. Also, the best strategy in the game then became playing arbitarge, snatching up these stocks with the measly adjustment and holding them until delist. Traders complained that playing arbitrage was safe and boring, and they only bought arbitrage stocks because they had to in order to maintain their LB status. That is why HSX introduced the 2.9x multiplier system.

So, why not turn off volatility on adjusted stocks, making it worthwhile to hold openers and not causing a huge demand on the server since people know they need to log on to sell off? HSX certainly could do this, and they have done it on a few occasions. But there is another problem associated with this, although it is more of a problem in game concept. HSX uses the four weekend delist period in order to give a longer time frame for films to show their worth. Frequently, traders have complained that the four weekend period is too short, forbidding them from holding nice leggy films like TITAN, AUSTI, GOODW, etc. when there is lots of cash to be left in them. If HSX adjusts a stock and turns off volatility, they may as well ignore every weekend but the first and make the game solely based on opening weekend box office. While this is workable, I have a problem with it since it ignores the legs of a film and makes HSX become one more power reinforcing the “opening weekend is all we care about” emphasis that has had such a deleterious impact on the way Hollywood markets films. I for one like that the fact that HSX does look toward the longer term.

So, what are the options?

1) we can live with the system as is, with post adjustment stocks occasionally becoming arbitrage, but rarely being anything to write home about, and toning the volatility down to where it was before the last few weekends, when drop-offs have been rampant.

2) Turn off Volatility altogether on adjusted stocks, or just delist them after opening weekend, which is essentially the same thing.

3) Move to a dividend model, where every monday a stock is adjusted and its previous week’s take as cashed out, until the stock falls off the box office charts. The downside of this is that since HSX doesn’t run on a bid/ask system (nor should it – a bid/ask system for virtual money works much better in theory than in practice – ask anyone who has played The Box), they would need to adjust and hand out cash for 50-60 films every Monday. Bleah.

4) My preffered alternative: Shut off the volatility of adjusted stocks for one or two days after adjustment. If this were combined with the ability to short sell, released stocks might become interesting again a couple of weeks later, but automatic aribitrage, Sunday Night server crashes, and $20 MNIRN massacres should be a thing of the past.

“Garcon, more bearnaise sauce. The feathers make it taste a bit dry!”

munch munch

Tom Miller

 Strategy Guide Note: Actually, the concept of expected value is very similar to risk arbitrage. Read both columns and decide for yourself (-Huy).

Many people, including myself, have noted that there is a large amount of risk in holding BWLLS through adjustment. Given the facts that:

1) BWLLS’ new calculated TAG is only slightly above that needed for an adjustment (50.34 vs 50),
2) HSX uses a different source for numbers, unavailable to traders, to calculate TAGs, and
3) HSX has had data entry errors in two bonds in the past two weeks

there is a very real chance that BWLLS will not be adjusted upwards.

On the other hand, if he is adjusted, he will jump from his current price of $944 to $1400, a whopping 48% gain! How do you weigh the potential gain on one hand to the chance that it won’t happen on the other? One way is to adjust BWLLS’ gain for the risk involved, but this is a bit arbitrary, since your risk adjustment has to do with your personal preference to seek or avoid risk. Another, more mathematically precise way, is to calculate the “Expected Value” of the purchase, assigning probabilities to various outcomes. This is how mathematicians and professional gamblers decide whether a bet is a good one. Here is how you do it:

There are two possible outcomes for BWLLS:

1) BWLLS is adjusted. If he is adjusted, he will move to $1400, prompting a mass sell off. You should be able to sell your bonds for around $1300, however, so lets use $1300 as the value for this outcome.

2) BWLLS is not adjusted. If he is not adjusted, this will also prompt a mass sell off, probably also knocking the price of BWLLS down about $100, so lets use $844 as the amount of value from this outcome.

The next step is use our wisdom and experience to assign probabilities to the possible outcomes. Given that IMDB data has been used to successfully predict bond adjustments many times before, we know there is a strong correlation between the data that HSX has and the data the IMDB has. Also, lacking any information to the contrary, it is as likely for HSX’s box office data to be OVER what the IMDB has as it is to be under (that is, there may be random error in the data, but the data is unbiased in any specific direction) . However, if HSX’s data is under at all, it will quite possibly lead to no adjustment. Therefore, I will assign a probability of .5 to each outcome, meaning there is a 50/50 chance for each outcome to occur.

Once probabilities are assigned, we multiply the probabilities for each outcome by the value from each outcome, and add them together. ($1300*.5)+($844*.5) = $1072.

So, given these probabilities and these outcomes, the Expected Value of BWLLS after the adjustment is $1072. Which amounts to an expected 14% gain on $944 bond.

It should be noted that if you believe the probability for Outcome 1, an upward adjustment, is below .22, (a 22% chance) then the expected value of the purchase is one which will lose you money, but for any probability greater than that, the bond is a buy.

Feel free to assign your own probabilities, but I believe the chance of an upward adjustment is greater than 50%, since I believe HSX is accurate more often than not, and I believe that an error in the data is as likely to happen downwards as it is upwards. This doesn’t mean the adjustment will happen, but it means I think it is a good bet.

Lord I was born a gamblin’ man

Tom Miller