My dear Pearson

My dear Pearson,

A note before the formal paper, because the matter sits uneasily with me and I would rather trouble you privately than in print.

You will recall the bulletin from the exchange observers: expiration weeks of the index options show an average premium of 0.35 per cent, attributed to the mechanical hedging of the dealers. The number is stated with confidence. What troubles me is not the number but the silence around its parentage. How many expiration weeks were examined, over how many years, and how many other week-types were catalogued in the same sweep? A premium of this size, recurring four times in twelve months, will confirm itself in nearly any decade you care to name. The proper question is not whether the premium appears - it does - but where a selection drawn at random from a population of noise signals would sit relative to it. I suspect uncomfortably close.

Here is the point I want you to weigh. The mechanism proposed - dealers buying and selling to neutralise their exposure as the contracts decay - is a real mechanism, and it operates on a schedule. But a mechanism on a schedule is a mechanism known to every participant who cares to look, and the profit that survives public knowledge is not the profit first measured. The regression prior applies with full force: the exceptional week is exceptional partly because it was measured before it was exploited. Watch the premium after publication and you will see the distribution reclaim its own. This is not cynicism; it is the same law that took the tallest fathers’ sons back toward the mean.

The exception interests me precisely as the place where the law shows its seams. If the premium were smooth, distributed across all weeks, we should learn nothing - the market would be a quincunx with no visible pins. It is the concentration at four dates in the year that lets us see the hedging flow as a physical force, the way the composite photograph reveals the type only when the individual faces blur away. But see it quickly. The seam will be stitched over.

I shall keep my series running through the next four expirations regardless of what the first shows. The phenomenon continues unresolved, and I am still watching it.

Yours ever, F.G.