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Comment by jkhdigital | Hacker News Reader

Bad ideas are magical when they come in the form of long call options (bounded cost, unlimited upside).

Bad ideas destroy companies/nations/civilizations when they come in the form of short put options (bounded benefit, unlimited downside).

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Not sure what this metaphor adds, especially because it's inaccurate.

A short put does does not have unlimited downside as the value of the underlying can only go to zero. A short call has unlimited downside as the value of the underlying can go arbitrarily high.

For sure, but the return distribution of equities at least was historically highly negatively skewed. There can be upside volatility in stocks, but it has either no persistence or it happens just after a massive crash. Taking this skewness into account, it is not unreasonable to consider short puts more risky in a very handwavy and back-of-an-envelope calculation.

Of course, other assets with more symmetric distributions (FX?) might have no such bias.

Great point. I wasn't even thinking of this in a larger context. I wonder if the downside is more important than the upside. So if it's just me trying to build an experimental aircraft, at worst I die. If I'm a city planner, I can make a bunch of lives miserable. Not sure what the upsides would be in either case, but the number of people affected by the downside is pretty easy to tell. So maybe the fewer people affected by a bad outcome, the more radical your ideas can be.

Succinct and accurate. A couple of real examples: the famous LTCM https://en.wikipedia.org/wiki/Long-Term_Capital_Management blew up in one of the late 90s financial crises by doing something that was almost exactly that (writing a lot of puts)

The 2008 mortgage crisis didn't have unlimited downside, but an awful lot of parties were making tiny slivers of money off things they thought had zero chance of default whose default risk was both higher and correlated.

Nuclear power arguably goes in this category too: it's mostly great, which is why people quoting numbers of deaths claim it's safe, apart from the couple of catastrophes that have left huge areas of contaminated land.

If you're trying something that has no risk to others and the worst case for you is the loss of your investment, feel free to go for it. If the worst case affects others negatively or your liability might be more than your investment, you should definitely think twice.

Oh, and be very careful about margin investing and options trading for non-specialists.

There was nothing fundamentally wrong with LTCM's business model, or with writing puts. Where they failed was in their execution - they underestimated the risk of fat-tails, and the level of correlation between different securities.

There are lots of cases where we do things that could potentially be catastrophic, but we do them anyway because the risk-reward justifies it. For example, going on a road trip instead of sitting at home and watching TV. The upside of going on a road trip is bounded (fun holiday) but the downside is catastrophic (deadly car crash). If we avoided every single activity that involved catastrophic risk, our lives would be far worse.

True. Also: when one is in a local maximum, bad ideas are the easiest way to get in the attraction basin of a better one.

Ideas should have a lot of "volatility", so yeah, this makes a lot of sense.

But of course, the usual environment of the financial world does not apply. "Bounded" can still be large enough to break a nation.

This is indeed very well put. However sometimes due to nature of the idea it is hard to evaluate the extent of downside in advance and what may seem like a limited downside actually turns out to be worse.

> long call options

> short put options

I tried to think of what a "short call option" or a "long put option" would be, and I don't think the concepts exist. Do they?

If you buy a call option, someone has to be on the other side of the contract. They are the short position.

Sure, but they don't have a call option. All they have is an obligation.

Short just means they have a negative amount of that, in this case a negative amount of options.

No, short means your position is predicated on the idea that the future price of something will be lower than the current price.

Owning a positive number of put options makes you short the underlying stock, which is presumably why the comment upthread described put options as "short put options". Selling put options gives you a long position, not a short position.

I wanted to analyze this in terms of the original comment, in which "short put options" have limited upside and unlimited downside, but put options do not have unlimited downside for either the buyer or the seller. The buyer can't lose more than the price of the option, and the seller can't lose more than the strike price. Put options are a case of "limited upside, limited downside" from any perspective.

Call options are the ones with unlimited upside (for the buyer) and unlimited downside (for the seller).

You have to think of the futures definition of long and short, not the equities definition of short. In every futures contract, the long is paying money and the short is receiving it for the contract. Every options contract has a short, the writer, and a long, the buyer.

In this case, the original commenter explicitly (erroneously) stated "options". Options cannot have unlimited downside; you can always choose not to exercise the option.

If you write a put option, it has downside limited only by the underlying zero price of the security minus the premium. If you write a call option, your downside is theoretically unlimited. If you buy a put or a call your downside is limited to the option premium.

edit: i should say writing a put option (short put) your potential downside is the difference between the strike price of the option and the premium, if the underlying security goes to zero.

If the underlying security goes below zero, that doesn't increase your potential downside. The option you sold will force you to buy the security, but it won't force you to sell it.

Thanks for clarifying

> short means your position is predicated on the idea that the future price of something will be lower than the current price.

Yes, but in this case the "something" is the option, not the underlying. This is completely standard use of the word "short" in the finance industry.

Generally a “long call” would mean that you bought a call option. If you sell/write the contract, you’re short. Your position is in the derivative instrument itself, it's not cascaded onto the underlying.

I also know multi-layered derivatives such as options on options and options on futures exist (as I’ve written code for them), but I’m curious what they’re used for.

Options on futures are mostly just a convenient way to specify an option on the underlying product. Instead of having the option to buy gold bars (which trade on a different exchange), you have the option to buy gold futures, which has 99% the same behaviour in terms of price.

Options on options are pretty esoteric, I've never heard of anyone actually using one. I guess you can get very leveraged exposure to volatility that way, if that's what you need.

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