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Bad ideas are magical when they come in the form of long call options (bounded cost, unlimited upside). Bad ideas destroy companies/nations/civilizations when

Bad ideas are magical when they come in the form of long call options (bounded cost, unlimited upside). Bad ideas destroy companies/nations/civilizations when they come in the form of short put options (bounded benefit, unlimited downside).

sudeepj 6y ago
This is indeed very well put. However sometimes due to nature of the idea it is hard to evaluate the extent of downside in advance and what may seem like a limited downside actually turns out to be worse.
082349872349872 6y ago
True. Also: when one is in a local maximum, bad ideas are the easiest way to get in the attraction basin of a better one.
thaumasiotes 6y ago
> long call options > short put options I tried to think of what a "short call option" or a "long put option" would be, and I don't think the concepts exist. Do they?
- ekelsen 6y ago
  If you buy a call option, someone has to be on the other side of the contract. They are the short position.
  - thaumasiotes 6y ago
    Sure, but they don't have a call option. All they have is an obligation.
    - brewmarche 6y ago
      Short just means they have a negative amount of that, in this case a negative amount of options.
      - thaumasiotes 6y ago
        No, short means your position is predicated on the idea that the future price of something will be lower than the current price. Owning a positive number of put options makes you short the underlying stock, which is presumably why the comment upthread described put options as "short put options". Selling put options gives you a long position, not a short position. I wanted to analyze this in terms of the original comment, in which "short put options" have limited upside and unlimited downside, but put options do not have unlimited downside for either the buyer or the seller. The buyer can't lose more than the price of the option, and the seller can't lose more than the strike price. Put options are a case of "limited upside, limited downside" from any perspective. Call options are the ones with unlimited upside (for the buyer) and unlimited downside (for the seller).
        projektfu 6y ago
        You have to think of the futures definition of long and short, not the equities definition of short. In every futures contract, the long is paying money and the short is receiving it for the contract. Every options contract has a short, the writer, and a long, the buyer.
        homeless_engi 6y ago
        In this case, the original commenter explicitly (erroneously) stated "options". Options cannot have unlimited downside; you can always choose not to exercise the option.
        projektfu 6y ago
        If you write a put option, it has downside limited only by the underlying zero price of the security minus the premium. If you write a call option, your downside is theoretically unlimited. If you buy a put or a call your downside is limited to the option premium. edit: i should say writing a put option (short put) your potential downside is the difference between the strike price of the option and the premium, if the underlying security goes to zero.
- ptr 6y ago
  Generally a “long call” would mean that you bought a call option. If you sell/write the contract, you’re short. Your position is in the derivative instrument itself, it's not cascaded onto the underlying. I also know multi-layered derivatives such as options on options and options on futures exist (as I’ve written code for them), but I’m curious what they’re used for.
  - dmurray 6y ago
    Options on futures are mostly just a convenient way to specify an option on the underlying product. Instead of having the option to buy gold bars (which trade on a different exchange), you have the option to buy gold futures, which has 99% the same behaviour in terms of price. Options on options are pretty esoteric, I've never heard of anyone actually using one. I guess you can get very leveraged exposure to volatility that way, if that's what you need.
pjc50 6y ago
Succinct and accurate. A couple of real examples: the famous LTCM https://en.wikipedia.org/wiki/Long-Term_Capital_Management https://en.wikipedia.org/wiki/Long-Term_Capital_Management blew up in one of the late 90s financial crises by doing something that was almost exactly that (writing a lot of puts) The 2008 mortgage crisis didn't have unlimited downside, but an awful lot of parties were making tiny slivers of money off things they thought had zero chance of default whose default risk was both higher and correlated. Nuclear power arguably goes in this category too: it's mostly great, which is why people quoting numbers of deaths claim it's safe, apart from the couple of catastrophes that have left huge areas of contaminated land. If you're trying something that has no risk to others and the worst case for you is the loss of your investment, feel free to go for it. If the worst case affects others negatively or your liability might be more than your investment, you should definitely think twice. Oh, and be very careful about margin investing and options trading for non-specialists.
- whack 6y ago
  There was nothing fundamentally wrong with LTCM's business model, or with writing puts. Where they failed was in their execution - they underestimated the risk of fat-tails, and the level of correlation between different securities. There are lots of cases where we do things that could potentially be catastrophic, but we do them anyway because the risk-reward justifies it. For example, going on a road trip instead of sitting at home and watching TV. The upside of going on a road trip is bounded (fun holiday) but the downside is catastrophic (deadly car crash). If we avoided every single activity that involved catastrophic risk, our lives would be far worse.
high_derivative 6y ago
Not sure what this metaphor adds, especially because it's inaccurate. A short put does does not have unlimited downside as the value of the underlying can only go to zero. A short call has unlimited downside as the value of the underlying can go arbitrarily high.
- short_sells_poo 6y ago
  For sure, but the return distribution of equities at least was historically highly negatively skewed. There can be upside volatility in stocks, but it has either no persistence or it happens just after a massive crash. Taking this skewness into account, it is not unreasonable to consider short puts more risky in a very handwavy and back-of-an-envelope calculation. Of course, other assets with more symmetric distributions (FX?) might have no such bias.
marcosdumay 6y ago
Ideas should have a lot of "volatility", so yeah, this makes a lot of sense. But of course, the usual environment of the financial world does not apply. "Bounded" can still be large enough to break a nation.
surjansingh 6y ago
Great point. I wasn't even thinking of this in a larger context. I wonder if the downside is more important than the upside. So if it's just me trying to build an experimental aircraft, at worst I die. If I'm a city planner, I can make a bunch of lives miserable. Not sure what the upsides would be in either case, but the number of people affected by the downside is pretty easy to tell. So maybe the fewer people affected by a bad outcome, the more radical your ideas can be.

sudeepj 6y ago

This is indeed very well put. However sometimes due to nature of the idea it is hard to evaluate the extent of downside in advance and what may seem like a limited downside actually turns out to be worse.

082349872349872 6y ago

True. Also: when one is in a local maximum, bad ideas are the easiest way to get in the attraction basin of a better one.

thaumasiotes 6y ago

> long call options > short put options I tried to think of what a "short call option" or a "long put option" would be, and I don't think the concepts exist. Do they?

ekelsen 6y ago
If you buy a call option, someone has to be on the other side of the contract. They are the short position.
- thaumasiotes 6y ago
  Sure, but they don't have a call option. All they have is an obligation.
  - brewmarche 6y ago
    Short just means they have a negative amount of that, in this case a negative amount of options.
    - thaumasiotes 6y ago
      No, short means your position is predicated on the idea that the future price of something will be lower than the current price. Owning a positive number of put options makes you short the underlying stock, which is presumably why the comment upthread described put options as "short put options". Selling put options gives you a long position, not a short position. I wanted to analyze this in terms of the original comment, in which "short put options" have limited upside and unlimited downside, but put options do not have unlimited downside for either the buyer or the seller. The buyer can't lose more than the price of the option, and the seller can't lose more than the strike price. Put options are a case of "limited upside, limited downside" from any perspective. Call options are the ones with unlimited upside (for the buyer) and unlimited downside (for the seller).
      - projektfu 6y ago
        You have to think of the futures definition of long and short, not the equities definition of short. In every futures contract, the long is paying money and the short is receiving it for the contract. Every options contract has a short, the writer, and a long, the buyer.
        homeless_engi 6y ago
        In this case, the original commenter explicitly (erroneously) stated "options". Options cannot have unlimited downside; you can always choose not to exercise the option.
        projektfu 6y ago
        If you write a put option, it has downside limited only by the underlying zero price of the security minus the premium. If you write a call option, your downside is theoretically unlimited. If you buy a put or a call your downside is limited to the option premium. edit: i should say writing a put option (short put) your potential downside is the difference between the strike price of the option and the premium, if the underlying security goes to zero.
ptr 6y ago
Generally a “long call” would mean that you bought a call option. If you sell/write the contract, you’re short. Your position is in the derivative instrument itself, it's not cascaded onto the underlying. I also know multi-layered derivatives such as options on options and options on futures exist (as I’ve written code for them), but I’m curious what they’re used for.
- dmurray 6y ago
  Options on futures are mostly just a convenient way to specify an option on the underlying product. Instead of having the option to buy gold bars (which trade on a different exchange), you have the option to buy gold futures, which has 99% the same behaviour in terms of price. Options on options are pretty esoteric, I've never heard of anyone actually using one. I guess you can get very leveraged exposure to volatility that way, if that's what you need.

pjc50 6y ago

Succinct and accurate. A couple of real examples: the famous LTCM https://en.wikipedia.org/wiki/Long-Term_Capital_Management https://en.wikipedia.org/wiki/Long-Term_Capital_Management blew up in one of the late 90s financial crises by doing something that was almost exactly that (writing a lot of puts) The 2008 mortgage crisis didn't have unlimited downside, but an awful lot of parties were making tiny slivers of money off things they thought had zero chance of default whose default risk was both higher and correlated. Nuclear power arguably goes in this category too: it's mostly great, which is why people quoting numbers of deaths claim it's safe, apart from the couple of catastrophes that have left huge areas of contaminated land. If you're trying something that has no risk to others and the worst case for you is the loss of your investment, feel free to go for it. If the worst case affects others negatively or your liability might be more than your investment, you should definitely think twice. Oh, and be very careful about margin investing and options trading for non-specialists.

whack 6y ago
There was nothing fundamentally wrong with LTCM's business model, or with writing puts. Where they failed was in their execution - they underestimated the risk of fat-tails, and the level of correlation between different securities. There are lots of cases where we do things that could potentially be catastrophic, but we do them anyway because the risk-reward justifies it. For example, going on a road trip instead of sitting at home and watching TV. The upside of going on a road trip is bounded (fun holiday) but the downside is catastrophic (deadly car crash). If we avoided every single activity that involved catastrophic risk, our lives would be far worse.

high_derivative 6y ago

Not sure what this metaphor adds, especially because it's inaccurate. A short put does does not have unlimited downside as the value of the underlying can only go to zero. A short call has unlimited downside as the value of the underlying can go arbitrarily high.

short_sells_poo 6y ago
For sure, but the return distribution of equities at least was historically highly negatively skewed. There can be upside volatility in stocks, but it has either no persistence or it happens just after a massive crash. Taking this skewness into account, it is not unreasonable to consider short puts more risky in a very handwavy and back-of-an-envelope calculation. Of course, other assets with more symmetric distributions (FX?) might have no such bias.

marcosdumay 6y ago

Ideas should have a lot of "volatility", so yeah, this makes a lot of sense. But of course, the usual environment of the financial world does not apply. "Bounded" can still be large enough to break a nation.

surjansingh 6y ago

Great point. I wasn't even thinking of this in a larger context. I wonder if the downside is more important than the upside. So if it's just me trying to build an experimental aircraft, at worst I die. If I'm a city planner, I can make a bunch of lives miserable. Not sure what the upsides would be in either case, but the number of people affected by the downside is pretty easy to tell. So maybe the fewer people affected by a bad outcome, the more radical your ideas can be.