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Hedge fund guy here. I actually met NNT, fun character. Irreverent as always. He was talking exactly about this strategy when he came in. The thing is, trading
by lordnacho 3y ago
Hedge fund guy here. I actually met NNT, fun character. Irreverent as always.
He was talking exactly about this strategy when he came in. The thing is, trading often presents you with a tough choice:
- Do something that on most days makes a bit of money, but sometimes creates big losses.
- Do something that on most days loses a bit of money, but sometimes gives you a big payday.
Your problem is then what to do. If you've decided that you want to wait for the big payday, how are you going to stay in business until your ticket comes in? How do you keep your investors faithful until then? This is the actual skill in this trade, btw.
If you're wondering about taking the other side, the trope is that you get an even bigger job after you get fired for losing a huge amount of money in an "unforeseen event".
- gjvc 3y agoExcellently put
- bombcar 3y agoI've also read that lots of traders make money before taxes and fees. They can use skill to determine things. But "picking pennies up in front of a steamroller" has it's downsides, too. And you can be absolutely correct about what is going to happen, but off on the date and get wiped out.
- skippyboxedhero 3y agoI would look at Universa's record, it is horrible. I know a few guys who make money doing this but it does require more than Universa appear to be doing. Practically, I have found short-selling funds are even better...but, for reasons you mention, the economics of running these funds mean that very few exist.
- rwmj 3y agoIsn't there also a massive counterparty risk, since you're trying to claim money when everyone else has lost money?
- nradov 3y agoFor publicly traded options there isn't much counterparty risk unless the financial system completely melts down. Counterparty risk is more of an issue with other derivatives traded off market. That risk can sometimes be partially hedged, for example by purchasing credit default swaps on the counterparty.
- lordnacho 3y agoIt's a risk, not something that you couldn't deal with. You have to have a sensible prime broker mainly. Any of the big ones will have systems in place to protect them well in advance of you putting on this huge put option. The only guys who would blow up from this were merged earlier this year. This is assuming the entire trade is just S&P500 puts of course. A proper doom merchant might put it on in a bunch of ways, with various swaps against counterparties in different assets. It's really just OTC risk you'd care about but again if your PB isn't incompetent you will know where you can do this.
- vajrabum 3y agoNNT is very entertaining. He's also blown up two hedge funds. Ever notice that running a fund is an asymmetric option? The management makes money either way at least until the investors leave, but there's no clawback if the fund blows up. So, I enjoy NNT. I respect his wit and intelligence. I'll even use his insights to steer my thinking. But he's not where I want my money going. And with his books and his trips to Washington perhaps he's gotten that bigger job.
- idoh 3y agoWhat were the hedge funds, what happened? I’m a fan of NNT, but I want to get a more complete picture of whether his “stuff” works or not, and good info is hard to come by.
- mhh__ 3y agoI'd also like to know.
- everybodyknows 3y agoA less successful example of this type would be Hugh Hendry, who after the implosion of his Eclectica fund is now seeking listeners willing to pay via Patreon for his weekly podcast recordings.
- blitzar 3y agoAnyone can be permanently bearish (it works both ways - the permanent market cheerleaders are just as bad in reverse) and then go on CNBC and tell everyone they correctly called every recession or bear market. Typically these people have called 176 of the last 8 recessions. There are plenty of fund managers out there that make some when its a bull market and make some in a bear market, they dont tend to go on tv and talk their book though.
- LatteLazy 3y agoYou're not wrong but... If you can get a 400:8 (50:1) returns, then betting on 176 recessions and winning 8 puts you well ahead of other traders.
- jmccaf 3y agoI'm less familiar with put and call options , compared to common shares and selling short; But one of the challenges to sell short, compared to buying long, is that your upside is limited and liability unlimited. Whereas the inverse for common stock, upside is unlimited and liability is limited. If you place 176 bets and win big 8, I think will be more successful buying long , like the venture capital model.
- LatteLazy 3y agoPeople say this, but of course if you invest via a hedge fund (or other similar corporate structure), your total downside is just whatever you invest. The fund maybe run up 1tn, or 1000tn in loses somehow, but that just means a lot of disappointed creditors meeting limited liability...
- oh_sigh 3y agoThere are options for limiting your losses, eg a bear put spread - buy put options at strike price X and sell put options at Y where Y < X.
- idoh 3y agoIf you buy an option (the right but not obligation to either buy or sell at a certain price), then your liability is limited to what you pay for it.
- miroljub 3y agoTaleb explained both phenomena and many others in "Antifragility" and "Skin in the game". Worth reading.
- OJFord 3y ago> the trope is that you get an even bigger job after you get fired for losing a huge amount of money in an "unforeseen event". Levine talks about this in Money Stuff in the sense of 'oh, they trusted you to lose a quadrillion dollars? You must be good'.
- AlbertCory 3y ago> I actually met NNT, fun character. Me, too. I hosted him at Google and now I have a signed copy of The Black Swan https://www.youtube.com/watch?v=S3REdLZ8Xis https://www.youtube.com/watch?v=S3REdLZ8Xis Anyone who talks about "permanent bears" does not get the concept.
- marban 3y ago- Do something that on most days loses a bit* of money, but sometimes gives you a big payday. Welcome to Startup Land * (or a lot)
- SkyMarshal 3y ago> Your problem is then what to do. If you've decided that you want to wait for the big payday, how are you going to stay in business until your ticket comes in? How do you keep your investors faithful until then? This is the actual skill in this trade, btw. I’ve been to one of the Wilmott-Taleb seminars in London. Taleb answered that question this way: 1. You buy way out of the money calls or puts which will eventually get you your big payday. Most sellers of these sort of options use Black-Scholes or similar model to price them, underestimating the frequency and/or magnitude of payout, and thus mis-pricing them. 2. Simultaneously you sell in-or-near-the-money puts or calls, which are more mathematically tractable, model-able, and thus manageable. Results in small and predictable income and payouts which you can manage to keep the fund afloat until #1 pays off. 3. Make sure your fund LP’s understand that this is essentially an insurance policy. People are accustomed to paying regular small payments for insurance against big unexpected events, and tend to accept that model for the fund too. As you say, the skill in this trade is in discovering options for #1 that are indeed mis-modeled and mis-priced, and in #2 managing that in/near-the-money portofolio as optimally as possible to cover or minimize the steady bleed from #1. It’s not easy.
- lordnacho 3y agoSuppose you are right. If the near-the-money options are correctly modeled, how will you make money on them?
- SkyMarshal 3y agoI don’t know, no one asked that followup question, everyone just accepted it. There’s probably more to it he didn’t elaborate on. I assume it depends partly on asymmetry of information between a more sophisticated option seller (like Universa) and buyers (especially retail). Maybe also the ability of the seller to sell a diverse heterogenous mix of options and construct the mix to achieve a small positive net revenue. Options sellers tend to blow up eventually when they sell way out-of-the-money options, and this strat avoids that at least.
- Majromax 3y ago> If the near-the-money options are correctly modeled, how will you make money on them? In a hand-wavy sense, they're the hedge. A mis-priced option isn't completely mis-priced: some of the modeling is correct enough. The trick to making money is to buy the mis-priced option, but then sell back the "part" of it that is correctly priced. That leaves you holding only the part where you think you have an edge, and in turns this is what makes the "insurance" model somewhat viable.
- cs702 3y agoThere's always a third choice: - Do nothing on most days, hold cash, earn a little interest, maybe play bridge to keep yourself entertained, and bet big only when you're sure you'll win big. Call it the Buffett approach. The main downside to it is that on most days you have nothing to do.
- m3kw9 3y agoYeah it’s called if you don’t have a strong view, you are just gambling. Bet big when you see it, but this takes experience as sometimes you think you see it but it’s really noise, or you have 5 big blind spots you didn’t consider
- HFguy 3y agoA fixed allocation to a one-size-fits-all tail risk fund doesn't work. It won't have positive returns over the long run. And its diversification benefit will not be enough to overcome the drag on performance. A tail risk strategy that is tailored to the portfolio, point in time, in an opportunistic way (e.g., when vol is cheap) can potentially work. But you need a strat like that to be part of the portfolio construction process. I dont believe that is what they are doing.