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Remember that a lot of data is not actually normally distributed, even though it looks so at first. The horror of "risk management" units of financial instituti

Remember that a lot of data is not actually normally distributed, even though it looks so at first. The horror of "risk management" units of financial institutions, when they get a "7-sigma" event twice in a month. Can you imagine there was a time when the entire US options market was running on flat volatility vs strike price (implying that financial asset prices are lognormal). Must have been cool to just buy the cheapest, most OTM options and collect big results every now and then.

bombcar 4y ago
Also if it’s once in 300 million to happen every day, it could happen to someone every day in the USA (assuming it’s something people do daily). If the outfall from a 7-sigma is disastrous, you have to try to prevent it, because it WILL happen eventually given enough goes.
- H8crilA 4y ago
  That's true but those people were sampling closer to once per day, and still got N-sigma in their models for some high value of N. The easiest way to get something that's not actually normal in the typical central limit theorem construction is to have the variables be just slightly not independent. Which becomes obvious in retrospect after you start realizing the dependence and shit hits the fan.
  - bombcar 4y ago
    Banks failing and CDOs exploding would be two good examples; they’re rare if not nonexistent but if they start they may all flare up. Also natural distribution assumes you don’t have someone trying to game the extremes to make money. If being seven feet tall resulted in billions we’d have people researching how to grow taller people. You can see stuff like this in distributions of tax returns - many people will be unexpectedly clustered right below certain cut-off amounts.
    - looping__lui 4y ago
      Worse is correlation break-down in a sense - e.g., that black swan event happening across an entire asset class because of liquidity squeeze, margin calls, etc.
  - deleted 4y ago
    [deleted]
- HankB99 4y ago
  > ... because it WILL happen eventually given enough goes. I'm not a statistician, but I don't think that's how that works. Given enough events, the likelihood of something happening goes up, but it never becomes a certainty. Likewise when the statistical 100 year statistical storm happens, the next one is not 100 years away. It could happen the following week without violating the underlying statistics. (Of course if a 100 year storm keeps happening year after year, then the threshold for what is likely to happen once in a hundred years probably needs to be revised.)
jrm4 4y ago
One time for Nassim Nicholas Taleb who's ALL OVER this in a deeply interesting and entertaining way. "The Black Swan" is great at going in on such a weirdly obvious-but-not point.
- paulpauper 4y ago
  Unlike other hedge funds, Taleb's/Universa's records, like CAGR, are sketchy. Good records do not exist except what has been 'leaked' to the media by PR. It's not like Bridgewater in this regard. His barbell OTM put strategy almost certainly did badly in 2022, because of the failure of the Vix index to spike and the decline of the S&P 500 being orderly. https://greyenlightenment.com/2022/10/08/tail-hedging-strategies-are-struggling-during-the-2022-bear-market/ https://greyenlightenment.com/2022/10/08/tail-hedging-strate... So both parts of the barbell lost money, which is not supposed to happen. This is why you have to be warry of individuals and strategies that are overhyped. If a strategy is getting a lot of positive press, it likely means it's saturated. If a lot of quants are buying the same options for the same hedging purposes, who is going to sell them?
  - jrm4 4y ago
    Judging Taleb by a hedge fund's performance, even if it's one of his, is really missing the point entirely.
paulpauper 4y ago
Can you imagine there was a time when the entire US options market was running on flat volatility vs strike price (implying that financial asset prices are lognormal). Must have been cool to just buy the cheapest, most OTM options and collect big results every now and then. This may have been possible pre-1987. Since then, out of money put options have a very steep skew, so not possible. Even if OTM put options are very cheap nominally, but by having much higher implied volatility makes them much more expensive compared to how much they would otherwise cost without the skew. This from a Kelly perspective makes them much less lucrative if one was to try to construct a strategy with this. It cuts your ROI big time.
- User23 4y ago
  In an efficient market the average ROI on options should be zero.
  - looping__lui 4y ago
    But it isn’t efficient; banks like overcharge you absurdly especially for OTM options.

bombcar 4y ago

Also if it’s once in 300 million to happen every day, it could happen to someone every day in the USA (assuming it’s something people do daily). If the outfall from a 7-sigma is disastrous, you have to try to prevent it, because it WILL happen eventually given enough goes.

H8crilA 4y ago
That's true but those people were sampling closer to once per day, and still got N-sigma in their models for some high value of N. The easiest way to get something that's not actually normal in the typical central limit theorem construction is to have the variables be just slightly not independent. Which becomes obvious in retrospect after you start realizing the dependence and shit hits the fan.
- bombcar 4y ago
  Banks failing and CDOs exploding would be two good examples; they’re rare if not nonexistent but if they start they may all flare up. Also natural distribution assumes you don’t have someone trying to game the extremes to make money. If being seven feet tall resulted in billions we’d have people researching how to grow taller people. You can see stuff like this in distributions of tax returns - many people will be unexpectedly clustered right below certain cut-off amounts.
  - looping__lui 4y ago
    Worse is correlation break-down in a sense - e.g., that black swan event happening across an entire asset class because of liquidity squeeze, margin calls, etc.
- deleted 4y ago
  [deleted]
HankB99 4y ago
> ... because it WILL happen eventually given enough goes. I'm not a statistician, but I don't think that's how that works. Given enough events, the likelihood of something happening goes up, but it never becomes a certainty. Likewise when the statistical 100 year statistical storm happens, the next one is not 100 years away. It could happen the following week without violating the underlying statistics. (Of course if a 100 year storm keeps happening year after year, then the threshold for what is likely to happen once in a hundred years probably needs to be revised.)

jrm4 4y ago

One time for Nassim Nicholas Taleb who's ALL OVER this in a deeply interesting and entertaining way. "The Black Swan" is great at going in on such a weirdly obvious-but-not point.

paulpauper 4y ago
Unlike other hedge funds, Taleb's/Universa's records, like CAGR, are sketchy. Good records do not exist except what has been 'leaked' to the media by PR. It's not like Bridgewater in this regard. His barbell OTM put strategy almost certainly did badly in 2022, because of the failure of the Vix index to spike and the decline of the S&P 500 being orderly. https://greyenlightenment.com/2022/10/08/tail-hedging-strategies-are-struggling-during-the-2022-bear-market/ https://greyenlightenment.com/2022/10/08/tail-hedging-strate... So both parts of the barbell lost money, which is not supposed to happen. This is why you have to be warry of individuals and strategies that are overhyped. If a strategy is getting a lot of positive press, it likely means it's saturated. If a lot of quants are buying the same options for the same hedging purposes, who is going to sell them?
- jrm4 4y ago
  Judging Taleb by a hedge fund's performance, even if it's one of his, is really missing the point entirely.

paulpauper 4y ago

Can you imagine there was a time when the entire US options market was running on flat volatility vs strike price (implying that financial asset prices are lognormal). Must have been cool to just buy the cheapest, most OTM options and collect big results every now and then. This may have been possible pre-1987. Since then, out of money put options have a very steep skew, so not possible. Even if OTM put options are very cheap nominally, but by having much higher implied volatility makes them much more expensive compared to how much they would otherwise cost without the skew. This from a Kelly perspective makes them much less lucrative if one was to try to construct a strategy with this. It cuts your ROI big time.

User23 4y ago
In an efficient market the average ROI on options should be zero.
- looping__lui 4y ago
  But it isn’t efficient; banks like overcharge you absurdly especially for OTM options.