Working with the economist (and his former professor at NYU) Nassim Nicholas Taleb —the author of the 2007 best seller, The Black Swan (Spitznagel is working on new book, Safe Haven: Investing for Financial Storms, for which Taleb is writing the foreword)—as an adviser, Spitznagel’s hedge fund has come up with a strategy to help big investors—for instance pension funds and endowment funds—protect their portfolios against the coming correction.
HatTip to Dave Lull
Universa Hedge Fund, a famous ‘Black Swan’ fund, made more than $1 billion in profits in one week amid volatility.The recent market rout caught some star Wall Street traders by surprise. But not a hedge-fund firm affiliated with “The Black Swan” author Nassim Nicholas Taleb, which gained more than $1 billion on a strategy that seeks to profit from extreme events in financial markets.
Universa Investments LP was up roughly 20% on Monday, according to a person familiar with the matter, a day when the Dow Jones Industrial Average collapsed more than 1,000 points in its largest intraday point decline. The blue-chip index finished down 588 points on the day.
The fund’s returns for the year climbed to roughly 20% through earlier this week, this person said. Universa holds positions designed to protect about $6 billion in client assets, according to people familiar with the firm.
“This is just the beginning,” said Universa founder Mark Spitznagel, referring to the market volatility this week. His longtime collaborator, Mr. Taleb, who advises Universa, is a professor at New York University and is known for his pessimistic forecasts on the global economy.
NNT did an AMA on Reddit yesterday. I’ve collected his responses in this post. You can see the entire exchange here.
[–]nntaleb Indeed. ATM drops faster, OTM rises. The same idea of shadow theta. Also project that the delta will go lower over time.
[–]nntaleb I wish you both luck and patience.
[–]nntaleb 1) These are bogus. Just look at past forecasts, made in 2000. We had to wait a decade to see returns. 2) I think people overestimate what financial markets can deliver to them for their retirement.
[–]nntaleb You cannot estimate future returns… Wrong approach to quantify that. OTM puts are OK if you spend little and they allow you to hold stocks you like. But again, best thing is to not rely on your retirement portfolio to feed you in old age.
[–]nntaleb Only try to make money from business. That is what Fat Tony would say. The business you know best. Options can be a business but it takes 3-4 years to understand it. It is real compared to investing, more like insurance/actuarial science.
[–]nntaleb I am about to publish my lecture notes in Silent Risk for how to price options using power laws. Very different paradigm. Vol clusters less when you use the right model.
[–]nntaleb The book is free. Here www.fooledbyrandomness.com/FatTails.html
[–]nntaleb No vanilla will hedge a compound option. So you can “dominate” it by buying tons of OTM vanillas around it
[–]nntaleb Vol of vol… since then I have evolved into more complex representation using “scale” and “tail exponent” which is easier to manage mathematically.
[–]nntaleb It is exactly the definition of a short squeeze. Same with the EURO. Violent moves against a trend, suckers covering. These are very astonishing in regularity.
[–]nntaleb If you are asking that question, do not use options. Short with a stop.
[–]nntaleb I do not believe in simplified solutions: humans recreate institutions, in an organic way. Scale matters more than whether there is a goverment or not. A coop in NY is a dictatorship. But it works because of size.
[–]nntaleb Hello. I don’t think so. OTM options are not that elevated in price. If anything people misunderstood my book to think that all options are underpriced, including At the Money options, which is wrong.
[–]nntaleb “Over time” the opposite strategy has blown up people. The problem is that large deviations happen, and all you need is one to lose years of carry. Sometimes, as we saw with subprime, centuries of carry.
[–]nntaleb Indeed! You make money when you are there during the panic. You sell 50% of inventory before you even start thinking what to do.
[–]nntaleb Marty O’Connell, The Business of Options.
[–]nntaleb Indeed, uberized; then there were pit traders, with a franchise. All gone.
[–]nntaleb I do not play cards.
[–]nntaleb Almost never, except when volatility is very very depressed, or some special situations. Usually have preferred selling those.
[–]nntaleb There is less worry about currency derivatives: it is more difficult to hide the risks today. Doesn’t mean people can’t blow up from underestimation of the odds. But the risk hiding is gone. It is the old risks that will blow firms up again: Fannie Mae is still the same using the same primitive mathematics.
[–]nntaleb If you have a reason to buy an option, don’t buy it. I only go by price.
[–]nntaleb In general it is not time per se but nonlinearity to volatility that counts, so a six month out of the money (measuring out of the moneyness in low delta) is preferable to a 1 year OTM with higher delta, for squeezes. Niederhoffer went bust with short term options… they went from .2 to $38 ! The advantage of shorter term is that vol explodes the most in them. Short but of course not too short.
[–]nntaleb I am not sure financial investment alone are good for retirement. Better invest in a small business like a bakery… really. Financial prices go through protracted periods of boom / slumber (or down-drift), see before 1982 or between 2000 and 2010…
[–]nntaleb I have sold vols into liquidations, no specific definition of a selling point. Butterflies… I do not do 1-2-1, rather +2 +1 -2 +1 +2 So the trade can be long or short vega, locally.
[–]nntaleb I made mistakes that hurt me, but also that made money by error. For instance I bought OTM options for the wrong reason (I mispriced them as there was a software bug ) before the New Zealand currency collapse in the 80s. I also got squeezed in oil, big time, on a deliverable option… learned to not venture in markets without knowing the “inner” problems.
[–]nntaleb By definition, a basket that moves in ways to neither make you happy nor unhappy. So some gold is there, some agris, some copper, some EUR, but nothing in quantities to bother me. Some gold companies have OTM stuff because extraction costs are higher than current market price. These are great to own if they are cheap.
[–]nntaleb A trend is not a well defined thing.
[–]nntaleb It is false to think that because electronic currencies are good, that bitcoin is the only solution… We need to tinker with different competing models there.
[–]nntaleb Please read comments. I am not against selling ATM premium. This is one of the nonsense people have spread in the interpretation of my ideas.
[–]nntaleb I think the calls are more interesting. You can see oil collapse, yet make jumps from short squeezes.
[–]nntaleb Indeed there is a niche. For specialized funds perhaps.
Excellent! See the entire list, link below.
A Dozen Things I’ve Learned from Nassim Taleb about Optionality/Investing
1. ”Optionality is the property of asymmetric upside (preferably unlimited) with correspondingly limited downside (preferably tiny).” Venture capital, when practiced properly by a top tier firm, is a classic example of a business that benefits from optionality. All you can lose financially in venture capital is what you invest and your upside can be more than 1000X of what you invested. Another example of optionality is cash held by a disciplined patient value investor with the temperament to not buy until Mr. Market is fearful. As just one example, Warren Buffett did exactly this during the recent financial panic and earned $10 Billion by putting his cash to work. Seth Klarman, Howard Marks and other value investors use dry powder in the form of cash to harvest optionality since Mr. Market is bi-polar.
2. ”‘Long volatility’ in trader parlance, has positive optionality.” As an example, the optionality of cash allows the holder to buy assets from people who were “short volatility” when a crisis hits. The wise value investor sits and waits patiently for Mr. Market to deliver a fearful market and when the intrinsic value of a company’s shares presents a “margin of safety” buys in quantity.
3. “If you ‘have optionality,’ you don’t have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells. For you don’t have to be right that often. All you need is the wisdom to not do unintelligent things to hurt yourself (some acts of omission) and recognize favorable outcomes when they occur. (The key is that your assessment doesn’t need to be made beforehand, only after the outcome.)” Being able to make decisions which do not require correctly forecasting the future is a wonderful thing. Not one of the great value investors identified in the series of posts in this blog relies on macro forecasts of the future. Instead, value investors use the optionality of cash to buy after the outcome exists (i.e., a significant drop in intrinsic value). Regarding venture capital, Warren Buffett believes: “If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually- independent commitments. Thus, you may consciously purchase a risky investment – one that indeed has a significant possibility of causing loss or injury – if you believe that your gain, weighted for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but unrelated opportunities. Most venture capitalists employ this strategy.”
A Dozen Things I’ve Learned from Nassim Taleb about Optionality/Investing | 25iq.
What do you mean by “fake low volatility?
You know the funds of Bear Stearns that blew up in the subprime crisis? They were funds that never had a down month. A lot of people who blew up in subprime did not have a down month—ever. And people rushed to invest in them because they were low volatility. And then they blew up.
Typically, I never get close to anything that has no volatility, unless it’s justified, like Treasury bonds. If you go to a balance sheet, you can see why there is low volatility, whether it is genuine. The company can have a barbell. The company can have very, very low leverage. Or you might discover that a company is doing the equivalent of selling remote options, and the company can lose a lot of money in one blow.
Let’s link it to make it more intuitive: In general, I can say that a system that has very, very low volatility is likely to blow up. Take the example of Syria. Syria had no political volatility for 40 years, and look what happened.
Forests that never have fires are likely to be completely eradicated by fires when they happen. Forests that have regular fires are much more stable.
