Nassim Taleb's “Black Swan” Fund Made 1 Billion On Monday
wsj.com
wsj.com
Taleb claims that options far from the current price are often underpriced. Whether or not this is the case is not clear.[1]
In 2009, Taleb was caught exaggerating his fund results.[2] Also in that year, he had a fund which bet on US dollar hyperinflation.[3] Wonder how that came out. He's not saying.
This is called the "cherry picking problem" in fund rating, and it's why, for public funds, the SEC requires funds to report 1, 5 and 10 year results after fees as their primary reporting numbers. For investment advisers, there's a rating service called Hulbert Digest, which subscribes to all those expensive newsletters and computes how you would have done if you followed their recommendations. Hulbert then publishes an expensive newsletter with the results. Taleb's fund is not checked by the SEC or Hulbert, so claims should be viewed skeptically.
[1] http://blogs.reuters.com/felix-salmon/2011/08/11/black-swan-... [2] http://www.businessinsider.com/wait-before-you-invest-in-nas... [3] http://www.wsj.com/articles/SB124519615631521063
Now, if your point is that Taleb doesn't explain it that way, you are right. But the only astonishing thing about this is that the WSJ deems it worthy of reporting that put options have gone up a lot when the market went down a lot.
Hedge funds, as a class, underperform the market; the "2 and 20" fee structure eats most of the gains. Yet many "qualified investors" buy into them.
Putting the fees aside for a moment, I think that hedge funds as a class can be expected to underperform long-only funds during a years long rally.
It does get more complicated as you pursue more sophisticated strategies though.
A short sale is an agreement for a party to buy a stock at a discounted price on the condition that the other party buy it for that person at a later date. That is, I say "That Chinese stock isn't any good. In two months the price will go down. So tell you what, you give me the money for that stock and you'll get your stock in two months, no matter what the price plus some extra as a discount. If that price goes down, I pocket the difference. If it goes up, I pay that difference as well out of my own pocket."
The article is behind a paywall, so I don't know what specific strategy he used. But it'd probably be something along those lines. A bet against someone that the price is going down using his own money.
Besides, that sort of risk is exactly what stock traders do for a living - analyze and account for risk. And Nassim is a specialist in a special kind of risk: risks people don't encounter often and thus systematically underestimate.
Just copy-paste the article's title in google, then click it and the paywall disappears.
Suppose Taleb buys a put on SPX (S&P500 index) from an counter-party with a strike price of 1880, most prudent counter-party would re-hedge themselves by spending some of Taleb's premium to buy a cheaper SPX at a strike price of 1800.
Alternatively, the counterparty might put on dynamic hedge; meaning if SPX drops and it gets closer to Taleb's strike price, the Taleb counterparty will have to rush out and also short number of shares of SPX proportional to the option's pricing's sensitivity to the SPX, otherwise known as the delta of the option contract.
Suppose the counterparty didn't hedge properly or the market was super-volatile like this week Monday and counterparty didn't act fast enough to hedge and is brankrupt; then usually the counterparty's broker has to steps in (e.g., Charles Schwab or TDAmeritrade for retail investors or a huge investment bank's brokerage services for a hedge fund).
Suppose the trade is so huge that the broker defaults (e.g., when Swiss Franc de-pegged and blown up lots of retail forex accounts and forex brokers), each broker also has to go through a clearing broker who are the third-level of guarantor of the option contract; the two biggest one's for equity and options markets in US are Goldman Sachs Execution Services and Apex Clearing. Their sole job is to maintain a huge account of cash proportional to the trades they settle in case of settlement issues.
Now suppose the GSEC and Apex defaults also; then I'm not sure anymore, I'm guessing that the guarantee responsibility falls upon the charter members of the option or equity exchange - the burden of debt is distributed to the member of the exchange (brokers, banks). If all the exchange collective members go bankrupt, then I guess at that point, that means collecting your option payment would be your least problem...
If AIG couldn't pay off, effectively Goldman's house is burning down, but their fire insurance company (AIG) has just gone broke. That is, until the US Government bails out AIG (and by extension Goldman).
GS has argued that they didn't need AIG b/c they were flat exposure to AIG. Technically, this may have been true, but unlikely. In any case, if AIG went under other folks who owed GS money would not be able to pay because AIG could not pay (and AIG owed everyone money). So really GS was very much tethered to AIG.
But you do bring up a good point. It's very difficult to make money betting on the end of the world, because if the world ends, who will be around to pay you. For these reasons, central governments/banks have been the underwriter of end of the world insurance through their lender of last resort functionalities.
Everyone seems to hate on derivatives, but nobody can argue that they don't provide the necessary granularity to exactly specify risk/reward profile of the position you're looking to hold.
Who knows - maybe everyone here is right and they got creamed for 7 years before making back 20%. My feeling is that the position was likely more thoroughly built than that. Again - who knows - but just hating on it at face value isn't doing anyone any favors in understanding the market and the way informed investors articulate their desired position in it.
Oh, "probably". Got it.
Taleb is very smart and very practical. I doubt he falls into the perma-bear trap. Even Japanese equities have had long positive runs that have not been worth fighting during their brutal bear market.
I always enjoy quotes like that. I wonder if the markets have gained 50% over the time he's been saying it.
Charitably, he might be saying that he long claimed markets were overvalued. Only an idiot would claim that markets were constantly overvalued by 50% while fluctuating all the time.
Unless you have a verbatim transcript, it's best not to assume that a stupid-sounding quote was said literally as quoted.
It's really frightening to know that the quickest, easiest way to make millions of dollars gaming the stock market is just to bet on global financial disasters, or bad news of companies, or crops failing.
How many other traders out there look forward to bubble bursting events like this? Commodity disasters? Oil disasters and shortages? The whole "dumb money" (retail trades, casual investments, passive investment funds) vs "smart money" (day traders, hedge funds, insider traders, HFT) would lead me to believe that it's beneficial to exploit the excessive pumping up and bursting of financial bubbles, as it only siphons up 'dumb money'.
Essentially your wealth is path dependent. Though the expected value may be positive, once you are ruined you cannot continue to play (or in this case) invest anymore.
In math you could theoretically always bet (or invest) a fractional value of your wealth, but not in the real world.
There's a +EV (long run, even with finite starting bankroll) strategy readily available under the stated conditions.
Yep, that is correct, but the kelly criterion requires fractional betting, which at some point in the real world is not possible, especially with options.
This is because there is a limited amount of options you can sell/purchase, so the fractional bet will always decrease as your bankroll increases. And there is also a floor where you cannot purchase below if your bankroll falls below (though your investors would have wiped you out by than).
That is suboptimal
The Kelly criterion is about optimizing the speed of growth of your bankroll when betting with an advantage, so it's still "safe" to round down.
My trading account is "nowhere near the size of Taleb's" (to put it mildly) and I don't use his strategy, but I've never found that I wished for fractional optional contract sizes. (I don't even use the mini-S&P options.)
When you're selling deep out of the money puts you can't just assume there will be a buyer to satisfy the fractional betting condition mentioned by the author in the (theoretically correct) kelly principle.
Not doing so is suboptimal
I guess we're just talking over each other - you made an assumption that I don't believe was clear from the context.
Meanwhile he made a 15-20% return, on a twice in a decade type of event, and isn't making public his annual returns every other time. (take a wild guess why?)
In short, not incredibly impressive.
Beyond that, consider why he makes money when there is a financial disaster? Because they act as some form if insurance on economic downturns, basically. A ton of it is bad (i.e. when the whole world profits by burning it down, you've got the wrong incentives!), but some of it can be quite healthy.
Not seeing anything frightening about that, but it all depends on what measure.
Also, correct me if I'm wrong but day traders / short sellers aren't obliged to keep the stock positions for any length of time.
I just find the phenomena interesting in context of financial bubbles, as the largest financial traders are incentivized to exploit instability of markets, and would be eager to create bubbles for the inevitable pop and profits on the plunges.