Four Ways to Master Your Dynasty League – Using Call Options to Buy Low and Sell High
I was going to write a long, flowy intro to this series that explained the underpinnings of RotoViz and captured the essence of our value-add. But then I realized that it already existed on the site. The article was written back in May of 2013 by @FantasyDouche and I still love the title: “What’s the Expected Value of Our Crazy-Ass RotoViz Ideas?” I want to dust off this particular article because it’s incredibly important to help frame what it is we’re doing when we write about lottery tickets like Dwight Jones, sleepers like Chris Boyd, super-sleepers like Charles Johnson, or any of the 30 wide receivers no one is talking about (who could be the next Miles Austin). I urge you to read that Crazy-Ass piece because it is the perfect foreword to this series, and more generally because it’s an invaluable roadmap to getting the most out of your RotoViz subscription.
In that same spirit of maximizing your expected value, my series serves three purposes:
Making you a better dynasty GM by helping you understand how dynasty players are priced and why those prices change.
Giving you a framework through which to apply our crazy-ass RotoViz ideas in your dynasty leagues.
Giving you some dynasty buy low and sell high targets based upon the framework.
I’ll achieve both of those things by drawing parallels between dynasty and financial markets – specifically call options. Without mincing any more words, here are the four reasons thinking about dynasty fantasy football as an options market will make you a dominant dynasty GM:
A dynasty league is a barter economy. You can’t be sitting in “cash.” You must always be swapping assets about to decline for assets about to appreciate. Otherwise capital is destroyed.
Option pricing dynamics help you understand why a player’s price is what it is by decomposing it into discrete parts. (Intrinsic value, Time To Maturity, Implied Volatility)
Option pricing dynamics help you understand how a player’s price will react to age (Theta).
Option pricing dynamics help you estimate how much a player’s price will change in response to changes in performance or situation (Delta).
Barter Economy – Dynasty Swap Meet
This may sound weird but I want you to stop thinking about your fake collection of football players as a team, and start thinking of it as a portfolio. A “team” is a group of players that interact with and thus influence each others’ performance (directly or indirectly). That’s not what happens with your dynasty portfolio. The constituents of a portfolio are independent. Each behaves on its own, regardless of what the others are doing. Each component can be evaluated in a vacuum.
While the timeless investing colloquialism “buy low, sell high” certainly still holds true for our dynasty portfolios, it falls a little short of the truth. A more accurate adage might be “Buy low and simultaneously sell high while somehow fleecing the other guy, who is probably reading the same stuff you are and stalking you on Twitter.” Not quite as catchy, but definitely more realistic. It’s really the first half of my sentence that’s most important…
If dynasty were about taking idle “cash” and buying players that were undervalued, or selling off players who are overvalued and pocketing the money until the next buying opportunity came along, it would be easy. Dynasty leagues are incredibly challenging because (unlike a traditional portfolio) every trade consists of actual players being simultaneously bought and sold. In stock market terms, that would be like paying for shares of Google with shares of Microsoft. The cost of purchasing those Google shares is dependent upon TWO variables (Google’s price AND Microsoft’s price) instead of just one (Google’s price in dollars).
Dynasty leagues behave exactly in this way – they’re a barter economy where goods are swapped for other goods instead of currency. Remember your old social studies textbook where “Joe the grain farmer brings four bushels of wheat to the market and uses them to buy two sheep from Sally the shepherd”? That’s a barter economy. What if a year later word gets out that John’s still trying to pawn off the stale dregs of that wheat crop from his leaky silo? Meanwhile, Sally now has a rep for breeding studs that yield twice as much wool as an average. What’s it going to take for John to acquire his two sheep this year? Eight bushels? Ten? Twenty? This is the exact situation we’re hoping to avoid in our dynasty leagues. You have to shed assets that are about to decline in value and use them to acquire assets that are about to rise in value.
We’ll never know for certain what will happen to a player’s value in the coming year, but using call options to think about players can help us do a better job projecting what might happen. As we decompose player price using call options, we’ll have a deeper understanding of what variables are driving that price and how they might change. That will allow us to get ahead of shifts in player pricing and truly create a Dynasty that contends in perpetuity.
Alshon Jeffery’s “Intrinsic Value” – Decomposing Player Price Using Call Options
I’m going to assume most readers aren’t intimately familiar with options. In order to illustrate just how well the two concepts relate I’ll walk through the basics of call options. If you are already an options guru, feel free to skip down to the “Mapping the Basics” section.
A call option is the right, but not the obligation (remember that one for later) to buy a stock at a specified price (strike price) for a limited amount of time (maturity date). For those of you wondering, a put option is just like a call option, but it’s the right to sell a stock at the strike price. Since we can’t short sell players in dynasty, put options aren’t applicable. (Imagine if we were able to though? Hmm…)
To illustrate, let’s create a fictitious stock with a ticker XYZ that is trading in the market at $10.00 per share. Now let’s say you buy a call option on XYZ that has a maturity date one year from today with a strike price of $10.00. Let’s say the market price of the option is $1.00 (that’s called the option premium). To be clear, in this example you don’t buy the actual stock, just the call option – which again is the right to purchase XYZ at $10.00 per share any time in the next year.
Now, consider these two future scenarios:
Scenario 1: In a year’s time, on the expiration date of the option XYZ is trading at $15.00. At that point you exercise your $10.00 calls (meaning you say “I want to buy the stock at $10.00” now), then you sell those shares in the market at $15.00. Now you’ve booked a net profit of $4.00 ($5.00 profit on the stock less $1.00 option premium = $4.00). If you’d bought the stock at $10.00 instead of the $10 strike call, you’d have a full $5.00 in profit because you wouldn’t have spent anything on option premium. You gave up a little bit of profit by buying the option, but you’ll see why in Scenario 2.
Scenario 2: In a year’s time, on the expiration date of the option XYZ is trading at $8.50. At that point, your $10 strike calls expire worthless because the stock was trading below $10.00. If you’d just bought the stock at $10.00 you’d have a loss of $1.50 but since you only bought the option, the most you can lose is the premium paid, or $1.00 in our example. In fact, the stock could go down to zero and with the call option the most you ever lose is simply the $1.00 in premium paid.
An even simpler way of understanding call options is to think of them as lottery tickets. The little bit you spend on the ticket is all you have to lose, yet you have a chance to make substantially more.
Mapping the Basics
This is where we get to the good stuff. All of the components we discussed in the above examples can be mapped to components of a player’s price in a dynasty league. I’m going to choose RotoViz darling Alshon Jeffery to illustrate:
XYZ Stock = Alshon Jeffery (or any player) in real life.
XYZ Stock Price = Alshon Jeffery’s real life stat line. His stock is priced once a week during the NFL season. (N.B. his stock may only be priced once a week but his option is priced continuously throughout the week all season long – trades can happen at any time).
XYZ Call Option = Alshon Jeffery in your dynasty league. You have the right but not the obligation (remember that one?) to put him in your starting lineup.
Option Strike Price = Alshon Jeffery’s backward-looking average fantasy points per game. (Including the most recent weekly observation). If his average points-per-game is 7.2 that represents the average expectation of what he brings to your lineup.
Option Maturity Date = The perceived end of Alshon Jeffery’s playing career
Now that we have the basics mapped, we can look at some examples of how the Alshon Jeffery call option price behaves just like the XYZ call option.
There are three elements that make up the price of the XYZ call option and the exact same is true of the Alshon Jeffery option:
Call Option Intrinsic Value – Driven by the current price of XYZ stock relative to its strike price. If XYZ stock were trading at $11.00 in our example the $10 strike calls would cost more like $2.00. $1.00 of profit is already baked into the $10 strike calls. The other $1.00 of the premium comes from #2 and #3.
Alshon Jeffery Intrinsic Value – Driven by the current price of Alshon Jeffery’s stock relative to his strike price. My recent piece “Josh Gordon, Marvin Jones, and the Naive Dynasty WR Ranking Model” was my attempt to get at what constitutes intrinsic value. Note from the Basics above that Alshon’s strike price is just his backward-looking average fantasy points per game (PPG), which is exactly the basis for my naive ranking model. If Alshon’s historical PPG was 7.87 and he has that breakout stretch of games, his stock price (real life stat line) is now running above his strike price (historical PPG). He now has intrinsic value, and he will cost you more than before his breakout stretch. The opposite is also true. His price will be slightly lower if he’s in a slump and scoring below his average PPG.
Call Option Time to Maturity – The amount of time left until the call option expires. Pretty simply, the more time an option has left before it expires, the more chance there is for the stock to finish above the strike price (aka “in the money”), and therefore the higher the premium you’ll have to pay. In our XYZ example if you buy the $10 strike 1 year calls at $1.00 and in six months XYZ stock is still trading at $10.00 in the market, your call option is probably only worth about $0.50 now since there’s now only half as much time left for XYZ to finish above $10.00
Alshon Jeffery Time to Maturity – The amount of playing time Alshon Jeffery has left in the NFL. Pretty simply, younger players are worth more than older players since they have more time to 1) put up points for your fantasy team and 2) hit their ceiling if they haven’t yet “broken out”. That age premium inevitably erodes to zero. The kicker with age premium is that it doesn’t decline in a linear fashion (more on that in Part II).
Call Option Implied Volatility – The likelihood that the stock will finish higher than $10.00 by the maturity date of the option. This is somewhat dependent upon #1 and #2 but also dependent upon how much the stock moves around. If it’s a stock that has historically traded between $9.00 and $11.00 over the past year, the chances it finishes higher than $10 are less than if the stock had traded between $2.00 and $18.00 over the past year. The premium for the $9 – $11 stock might be $1.00 but the premium for the $2 – $18 might be more like $6.00, because the latter has greater volatility and therefore a greater probability of finishing in the money, all things being equal.
Alshon Jeffery Implied Volatility – The likelihood that Alshon Jeffery will outperform his strike price (average more than his historical PPG) in the coming year. Really what we’re getting at here is the perceived upside of Alshon Jeffery times his perceived chance of realizing that upside. This is where the age-old “talent and opportunity” equation comes into play. The more talent (upside) people think Alshon Jeffery has, the more they’re willing to pay for his option. The more opportunity people think Alshon Jeffery has to reach his upside, the more they’re willing to pay for his option. Both of those factors have a positive correlation to the cost of the Alshon Jeffery option.
How Real Dynasty Options are Being Priced
I want to keep this as concrete as possible so before I go further with any more terms, here are some examples of how these factors are affecting the prices of different players right now. Below are the ADPs of four players between January 2013 and February 2014.
Brief side note: I was able to put these charts together thanks to the incredible work of Ryan McDowell over at the incomparable Dynasty League Football (DLF). Ryan tirelessly runs mock drafts all season long with DLF readers and publishes them on the DLF site so that we in the dynasty community have the privilege of a valuable second source for the value of our players. He was gracious enough to give me access to the data so that I could build a charting tool to use for these articles. Thanks, Ryan!!
Alshon Jeffery – Jeffery has seen a meteoric rise in price over the past year. I would argue that’s partially due to an increase in his intrinsic value – his points per game (PPG) in 2012 was 7.87 and skyrocketed to 17.07 by the end of 2013 – and partially due to an increase in his volatility – the talent portion of his equation probably got a small uptick as people started to realize he really was legit, but the opportunity portion took an even bigger bump as he proved he could be the 1b to Brandon Marshall’s 1a.
Andre Johnson – Conversely, Andre Johnson is almost entirely intrinsic value at this point. His average PPG over the past three seasons has been 13.46, 18.49, and 17.07. His volatility is actually negligible at this stage. His upside is well known and reached, and he has all the opportunity in the world as the number one wideout for the Texans. The fascinating thing about Johnson is that he’s really starting to see the effect of his decreasing time to maturity affecting his price. Despite still being a top 10 wide receiver in points per game over the past three seasons, Andre2000 is selling at WR27 prices in startups. Dynasty players are looking at his age 33 season coming up in 2014 and pricing in the end of his career being just a season or two away. (Hint for the upcoming section – his value isn’t getting higher any time soon. Shh!)
Montee Ball – Ball’s value is holding steady where it is almost entirely due to time to maturity and volatility. He doesn’t have a ton of intrinsic value (4.99 PPG) although he probably got a small bump with his solid performances towards the end of the 2013 regular season and playoffs. His talent is widely known as being “good, not great”. But his opportunity is becoming clear. It sounds like the Broncos probably won’t resign Knowshon Moreno, leaving the door open for Ball to step in as the lead back in 2014. The market is pricing Ball as such.
Christine Michael – Michael is coming off the board roughly in the same range as Ball and due to exactly the same components, but for a different reason. Michael is pure volatility; he logged just 18 carries in 2013. He clocks in at a negligible 2.63 PPG. Unlike Ball’s volatility which is opportunity based, Michael’s volatility is based on raw athletic talent. Despite still being blocked for playing time by an ever-beasting, still suspension-free Marshawn Lynch and a not-yet-dead Robert Turbin, Michael’s talent is still commanding a 5th round dynasty startup pick. As most know, Michael absolutely tore up the combine and is thought by many to be the heir apparent to the Seattle rushing throne. If Michael’s situation dials up that half of his volatility component – he’ll easily shoot into the top 24 picks of startup drafts (and possibly much higher).
With some illustrative examples under our belt, now we get into the really juicy stuff. In Parts II and III of my series I look at the second-order derivatives of option pricing affectionately known as “The Greeks” to see how they deepen our understanding of dynasty player pricing and allow us to take advantage of market inefficiencies. I’ll highlight some older players you should be thinking about selling, and also identify players whose implied volatility is either too high or too low.