NOAH
JACOBS

TABLE OF CONTENTS
2023.07.08-Letter-III
2023.01.08-Letter-II
2022.07.30-Letter-I

INVESTING

"The most critical asset I manage everyday is my time"

- Anon hedge fund manager

If you consider allocating time as investing, then I have been investing since I was very young.

More literally, I started options trading by 16 and was managing a hedge fund by 21. I did this from April 2022 to December 2023. The project was the cumulation of a number of efforts:

Age 16-17: Began swing trading a couple shares of Tesla. | Started playing around with options. | Lost money in penny stocks.

Age 18: Started an options trading club, Theta Capital, at the University of Michigan's Ross School of Business, not to be confused with the Dutch fund of funds. | Trading evolved to focus more on longing volatility with crude delta hedging.

Age 19: Decided I was to start a hedge fund; I liked selling vol at that point, so that would be core to the strategy. | With Noah Cox, my business partner in the endeavor, we started the first of two "test funds" for the impending actual hedge fund. | Independently studied for and passed the Series 65 exam, although I never registered as an investment advisor. | Joined EVO Trading Club, a trading Discord, where I shared strategies and stock analysis.

Age 20: Published what I believe to have been the "first" book on the GameStop short squeeze; if I recall correctly, it hit top 20 in "Derivative Investments" on Amazon's Kindle Store, a feat that required only something like 5 purchases. I still get $.20 from the book every 6 months. | Cox and I started an investing newsletter to share our thoughts and build interest in our fund. | Started a second test fund for the hedge fund. | Evo was disbanded.

Age 21: Started and managed hedge fund, Noahs' Arc. | Began building and managing the building of software tools for investing.

Age 22: Left hedge fund. | Continued building the software tools. See Hacking for more.

Age 23: Aggressively investing in my skill sets and whatever business endeavor I am working on.

By clicking on the left column, you can view the three semi annual letters sent to investors during my tenure at Noahs' Arc, the fund.

Last updated 2024.06.08

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Partners’ Letter I

Issued July 30th, 2022

Concerning performance since inception (April ‘22) to June ‘22

Introduction

As a part of trusting us as stewards to a piece of your portfolio at Noahs’ Arc, we will be providing two private letters each year, one concerning the first half of the year’s performance, and one concerning July through December’s performance. Given that you are already receiving our public newsletter that primarily deals with macroeconomic conditions, these letters will focus more on the portfolio itself and our management of it. 

We believe that by issuing them only every six months, we are better positioned to separate the noise from the signal and give you an information-dense commentary on what we feel we have done right in managing the partnership, as well as where we may need to grow. 

For this letter, we’ll explain what we learned in this spat of market volatility, we’ll highlight one of our favorite companies, Steel Dynamics, and, finally, we’ll discuss our hedging strategy and how we are adding an additional layer of strength for the event that the volatility continues. 

Much like with our newsletter, we’ll give an overview of each point within our executive summary for the time sensitive reader. 

Executive Summary 

Volatility, Volatility, and More Volatility - We selected high volatility sectors at a very volatile time. Without our strategy, this could have been disastrous, but with our strategy, it worked out quite nicely. Buying and holding STLD could have yielded us about -20.41% over this period, while using our strategy on STLD yielded us about -5.36% over the period. Going forwards, we have and will continue to add lower volatility names. 

An American Gem - Steel Dynamics is a founder run, employee centric sustainable steel producer doing everything it can to create a robust portfolio of projects meant to weather economic storms. We will continue holding our position in the company.

Hedging - The options we were buying to insure our portfolio were and are overpriced on a historical basis. They have risen exponentially to offset losses, but not as much as we wanted on a percentage basis. We’re adding an additional layer of protection (vertical puts) with a fixed maximum payout that should more readily cover some downside risk in the current market environment. 

Volatility, Volatility, and More Volatility

Trust us when we say that commodities companies are really quite volatile! They go up, and boy, do they go down.  

A flashy example from our own portfolio is Steel Dynamics (STLD): reaching a high just above $100 a share shortly after we began trading on it, the stock has gotten as low as $62.44, for  a 37.78% drawdown.

How has Noahs’ Arc fared on this investment to date? We’re happy to say that we’re not down 37.78% on the name.

As a reminder, to enter a position with our strategy, we sell out of the money puts; this essentially acts as a limit buy order on STLD that we get paid to place (the catch being that it would cost money to cancel the order). If we would have simply bought the stock at the closing price on each of the three days that we sold these puts, our return on the company at the end of June would have been about -20.41%. This is not what we did.

Instead, we sold puts and then continued to sell calls, helping us get in at a lower cost basis and generate income off this name while we’ve held it. Taking into account all of the income we produced from the company using our options strategy, our total return at the end of June on STLD was about -5.36%. In other words, our strategy succeeded in cushioning losses! We hope that this serves as a reminder as part of our initial value proposition: we seek to use our strategy to help absorb a substantial portion of the day to day volatility, on names and stories we love. We’re pleased to be able to say that this is holding true even in markets like this.

Unfortunately, like most investors who bought stocks in the second quarter, we selected equities that have had quite large drawdowns… we can assure you that STLD was not the only name in our portfolio that has this sort of story.

We got into volatile companies at a particularly volatile time. There is no way around it.

We began this venture with three sectors: Agriculture, Metals & Mining, and Banking. Two of these three are composed of producers of commoditized goods (Agro + Metals & Mining). While our exposure to both of these sectors involves a mix of different commodities, it was still quite a heavy dose of volatility early on. Adding to the million variables that can already influence a stock’s price, these companies are exposed to a significant one that is beyond their control: the price of the commodity that they sell.

As a solution to this, we’ve already added what is considered to be a much less volatile fourth sector: utilities. We are also considering a lower volatility fifth sector to enter with additional capital inflows and income from the portfolio. By reducing the percentage of our portfolio that is invested in commodity companies, we are able to maintain some level of exposure to the names we love, while not having a portfolio that is as susceptible to the ups and downs of commodity pricing. 

Back to Steel Dynamics: do we intend on selling the company, seeing as it had such a large drawdown?

No, of course not! While its price fluctuations are frustrating at times, we selected it for the above example to take the opportunity to share with you the story of the underlying business and why we love the steel producer. 

An American Gem

Any uncited claims in the below STLD coverage were sourced from the company’s annual and quarterly reports.

Steel Dynamics (NASDAQ: STLD), colloquially known as SDI, is a founder-run US steel company. The company is worker centric, sustainable, and focused on becoming robust enough to capture through-cycle profits in the world of steel.

Before we dig into the main points, we can’t help but mention the company’s founder-run nature: one of its three co-founders, Mark Millet, is running the business nearly three decades after its creation. As Noah and I travel further along our own entrepreneurial path, we’re increasingly realizing there's a certain attitude and level of skin in the game that comes with owning and operating a business that you’ve been with since day one... 

That’s not to say it’s impossible to recreate that feeling for others; as a matter of fact, this brings us to one of our key points: 8% of SDI’s profits are returned to employees of the company. In line with this, many employees see up to 40% of their salaries in performance bonuses. Children of each employee are also given a $5,000 scholarship each year to help attend a 4 year college as part of their generous compensation. The company has taken a decisive step to reduce labor risk by keeping labor on its side, and, so far, it has paid off: the employees have yet to unionize.

In regards to the environmental concerns, Steel Dynamics has gotten ahead of the issue: by only utilizing Electric Arc Furnaces ( EAF ), the majority of their raw material inputs are from recycled scrap steel. This is in contrast to more traditional Blast Furnace-Basic Oxygen Furnaces that require coal, iron, and limestone for use… that’s without even mentioning that a good portion of SDI’s scrap steel is sourced from its own recycling facilities. Pig iron is required for the mix, but due to recent Ukraine related supply chain constraints, the company has already nearly halved the quantity of this input needed.

Even with energy intensive electricity as a major input for the EAF’s, SDI’s net carbon footprint for making steel is about 8% of the global average for steel makers. Most impressively, their Indiana facility, run on a nuclear grid, has the lowest carbon footprint of any steel producer in the world according to Millet . Likewise, their facility in Mississippi is run off of hydro from the Tennessee Valley Authority, and is allegedly close to having the second lowest carbon footprint. That’s quite the ESG portfolio, and it’s hidden right inside of an industrial titan! 

SDI’s extra ordinary focus on sustainability not only reduces risk in their business model, but also creates an opportunity for more added value: at some point in the future, it’s not outside the realm of possibility for companies to pay a premium for green steel . That’s still in the future, but it’s an enticing possibility, nonetheless. Steel Dynamics has the potential to reduce the commodity pricing in its commodity business. Genius. 

Speaking of reducing commodity pricing, the final piece of the puzzle, fluctuating commodities prices, is perhaps the most difficult to solve for… After all, how can one avoid being at the mercy of the markets when the prices of the goods they sell go up and down daily? While the stock price may still move with the torrents of the market, the business has already taken steps (outside the potential green premium) to reinforce itself against shocks.

One of the most basic forms of steel is “Hot-Rolled Coil Steel,” traded using various futures contracts. Beyond this, a steel producer can add value to their products in a number of ways, reducing the commodity price nature of its products. This can be done by producing galvanized, pickled & oiled, painted, and cold-rolled steel, all of which are value-added features that Steel Dynamics (SDI) does today. Some 60 to 70% of their products are considered value add, which not only have better margins but also are more robust to commodity fluctuations. This acts as a competitive advantage in recessionary periods when overall steel demand decreases. 

Finally, while we were writing this letter, the company announced that it is expanding into the Aluminum space, and that it will be doing so in typical SDI fashion: not only is it creating an aluminum plant, but it will also be bringing satellite aluminum recycling facilities online to help control its inputs. They’re controlling the supply chain to make their business more robust. That’s important. 

While entering a new production line could be considered a risk, we trust that if anyone can do it and harvest the advantage of being a diversified commodity producer, it would be Mark Millet and the team at SDI. 

In our view, Steel Dynamics epitomizes what it means to be a robust company, insulating itself from a number of large ancillary risks and preparing itself for whatever market is to come. 

Hedging

The final item we’d like to address is our hedging strategy. The next paragraphs are technical, included here for the record. The explanation in the Executive Summary has been written non technically and to preserve meaning.

To cut to the chase, we’ve been purchasing (in hindsight) overpriced, deep out of the money (OTM) puts, and implied volatility (IV) has not been increasing as dramatically with the market decline as we expected. IV is a measure of the market's uncertainty and has a large impact on options prices, especially the prices of the options we’ve been selecting. Implied volatility’s lax increase may not be as surprising as we first thought, because it was already relatively high… hence the over-priced-options. 

This doesn’t mean our hedges haven’t worked; some have returned as much as 300-400% in gains. However, this is not the multiple we were shooting for in selecting these options. 

While we will continue to hold this type of deep OTM put to maintain a level of convexity to volatility (see Part IV subsection “ Convex Payoffs ” of our White Paper), we’re augmenting our strategy to better function in the high volatility environment we’re currently in. We’re keeping the deep OTM puts, but have added vertical put spreads that are much closer to the money - this sort of trade is structured in a way where we have limited upside, but do not have to pay as much for volatility. 

Given their capped upside, we will be able to trade in and out of these with greater insight into what we might miss if we sell out of them too quickly. We’ll still be employing deep OTM puts, but we will be more picky and patient in regards to their price and less dependent on them in the event the entire market and portfolio decrease in value.

Closing Remarks

The first three months of this venture have felt like a lifetime (in a good way!). In the context of markets, though, they were a drop in the bucket.

In the long term, we hope to be judged by more than our month to month performance. A meaningful period may be 3 to 5 years. In the mid-to-short term, however, we understand that the only metric you have to gauge us by is short-to-mid term performance. 

While we patiently wait for the track record to turn from months to years, we will continue to do what we can to smooth out market volatility and maintain the strength of conviction required to achieve outsized long term, compounded returns. 

We thank you for joining us as partners on this journey. 

With Gratitude,

Noah & Noah