Bloomberg: John Henry and the Making of a Red Sox Baseball Dynasty

[soxhop411]

Most interesting part of this article for me.
 

 
 
This owed a lot to a philosophical overhaul that Cherington says took place after the Dodgers trade and produced what were initially greeted as a series of odd decisions. Before the season, the Red Sox appeared to overpay a group of solid but unspectacular veterans who were signed to short-term deals—players such as Mike Napoli, Shane Victorino, and Stephen Drew. Sports radio callers suspected the front office of writing off the season as it waited for its younger talent to develop, an inexpiable sin in sports-crazed Boston. What was really happening, Cherington says, was a recommitment to a long-term strategy built on data, performance analysis, and finding hidden value. “In my conversations with John,” he says, “he has always stressed that it’s really hard to predict the future. He sees the game objectively. He was able to really look down deep into the engine and be impervious to all the pressure coming from outside.”

Henry thought they had let emotion cloud their judgment. “We’d gotten into this cycle,” says Cherington, “of retaining high-profile veteran players and trying to extend our success that way.” It hadn’t worked. Says Henry: “We went back to what had made us great for a very long time.”

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The scarcity of desirable free agents has sent the price of even middling players through the roof. “It’s gotten harder to spend money intelligently,” Henry concedes. This has shifted the premium in baseball toward drafting, developing, and extending future stars, which, since it can entail handing out multimillion-dollar extensions before players have fully proven themselves, adds a new dimension of risk. Henry says the Red Sox use as many as three “nonbaseball financial experts” to determine how much to spend on a particular player. Gennaro, the sabermetrician, is trying to adapt the Black-Scholes Option Pricing model to value aging stars. “All the things that traders do for a living, using information to predict the future and then understanding your risk tolerance, your appetite for risk, the variability of outcomes that could occur,” says Astros General Manager Luhnow, “that’s becoming commonplace in front offices today.”

 

http://www.businessweek.com/printer/articles/196587-john-henry-and-the-making-of-a-red-sox-baseball-dynasty

 

[AbbyNoho]

It took a while for these talents to blossom, because Henry’s passion shifted to music, girls, and mysticism. After stints at four different California colleges studying philosophy and Jungian individuation, he dropped out to play bass in a prog-rock band called Elysian Fields that performed a rock opera about aliens from the constellation Cassiopeia.

 
I am sad I've gone this far in my life without knowing this fact.

 

[Monbo Jumbo]

 
 
Gennaro, the sabermetrician, is trying to adapt the Black-Scholes Option Pricing model to value aging stars. 

 
Option pricing recognizes 'time decay' as options approach expiration. This time decay, measured as 'gamma,' increases as the option's life approaches its end. Portfolios holding too much 'gamma' need to be incredibly lucky to overcome the built in losses of the time decay. 
 
Translating option speak into baseball, and given other comments by the team, the Red Sox appear to be saying older players are relatively over-priced with too much built-in time decay. Option 'calendar spreaders' make money by owning options with lots of time remaining (young players)  while going short the rapidly decaying options that are approaching expiration (aging stars.)

 

[No Guru No Method]

 
I am sad I've gone this far in my life without knowing this fact.

 
Bet his freak-flag was flyin'.

 

[Skeesix]

 
Option pricing recognizes 'time decay' as options approach expiration. This time decay, measured as 'gamma,' increases as the option's life approaches its end. Portfolios holding too much 'gamma' need to be incredibly lucky to overcome the built in losses of the time decay. 
 
Translating option speak into baseball, and given other comments by the team, the Red Sox appear to be saying older players are relatively over-priced with too much built-in time decay. Option 'calendar spreaders' make money by owning options with lots of time remaining (young players)  while going short the rapidly decaying options that are approaching expiration (aging stars.)

I don't think it signals any such thing. Black Scholes simply gives an approximate value of an asset at a given time given a couple of assumptions derived from the boundary conditions of the heat equation which the BS equation is equivalent to (& thus why it works when those assumptions hold). People may use it in a particular way on finance but I see no reason that continues to hold in baseball.

Incidentally my first reaction when I read this news was to quizzically raise my eyebrow. Even within finance verifying those boundary conditions can be tricky. It's worth noting that there was a fund which was based specifically off of using this one option pricing scheme and it went broke in the early nineties when the collapse of the Soviet Union disrupted the market enough so that the assumptions in the model no longer held. Of course the BS equation is still a cornerstone of quantitative finance but as with anything mathematical it pays to not take things for granted.

 

[Monbo Jumbo]

No doubt you have studied Black Scholes more deeply than me. In fact, I haven't studied it at all. I only used it to earn a living.

 

[ALiveH]

I also make my living (in part) from BS.  So, I know that time decay is actually theta not gamma.  Gamma is the 1st (partial) derivative of delta.

 

[kieckeredinthehead]

"Guys I know way more about BS than this other asshole" -finance dudes.

 

[Shelterdog]

It's all Greek to me.
 
When in doubt on finance, always side with the guy who believes in the financial importance of lunar cycles.