Blowing Up:
This story compares and contrasts two archetypical and polar opposite investment bankers. One who is a knowledgeable gambler, your typical Wallstreeter, the other is Nassim Taleb (of the Black Swan fame) who trades in options. One can apparently make money by trading options – betting that the price of a stock will rise or fall. Here, my lack of financial knowledge clouds the details of how this works, but apparently it does. Nassim’s idea is that by having a balance of options (bets?) that a stock will go up and others that a stock will fall ensures that he wins – kind of like MPT, but with options. From the article, it sounds as though his portfolio value experiences drastic increases when the market goes haywire, but generally slowly bleeds in value.
This story compares and contrasts two archetypical and polar opposite investment bankers. One who is a knowledgeable gambler, your typical Wallstreeter, the other is Nassim Taleb (of the Black Swan fame) who trades in options. One can apparently make money by trading options – betting that the price of a stock will rise or fall. Here, my lack of financial knowledge clouds the details of how this works, but apparently it does. Nassim’s idea is that by having a balance of options (bets?) that a stock will go up and others that a stock will fall ensures that he wins – kind of like MPT, but with options. From the article, it sounds as though his portfolio value experiences drastic increases when the market goes haywire, but generally slowly bleeds in value.
This whole story was curious. The pin stripe Wallstreeter goes through
booms and busts, living large and then losing the shirt off his back. Nassim’s strategy makes for a hell of a
payday, just widely separated and sporadic in nature. No matter how well balanced (stocks, bonds,
international markets and REITs) your portfolio, if the market crashes, so does
the value of your portfolio. But with
Nassim’s options, you can cash in on a market crash. It seems like Nassim’s options allow you a
perfect negative correlation – that is, you could buy stock of company X and
watch its value grow with the company, but also buy an option betting the value
will drop; if the first half of your investment works, the second doesn’t, but
if the second half works, the first doesn’t.
I wonder if there is a way to buy a small but significant set of options
betting on a crash such that it would offset your losses in the event of a
market crash. Your portfolio value might
look like this:
This plot compares returns of a standard 7% return (red) to
a simplified options balanced model (blue), assuming in both cases a $5,000 per year contribution (Roth IRA).
The options balanced model has a 5% compound interest return, where I
assume the extra 2% is spent on options to balance your portfolio. Then, depending on a random number (if rand()
> 0.9), the market experiences a crash.
Your Portfolio loses half its value, but if you have options, you get a
bonus ($50,000). It’s a back of the
envelope style calculation, so I doubt the numbers are right, but it seems like
an interesting idea. I’m guessing the
devil is in the details – how much time can you spend buying options and how
much of a return can you expect from your options? But it’s an interesting idea and perhaps
someone will offer an interesting financial product to simplify this (option index
insurance?).
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