Barbell strategy: anyone is using it?

C

Cren1

Hi all, just a quick poll preceded by an explanation for those who don't know what I'm talking about.

This question is for those who don't consider themselves heavy traders but use options like a tool to aid medium and long term investment process; so your goal is not to frantically scalp the Gamma or hedge the Delta of your weekly options the day of an earnings announcement but to build a risky portfolio around the cheapest weighted average prices... then enjoy dividends and positive mark-to-market.

The barbell strategy is more like a philosophy than a real strategy because its principle can be translated differently according to the chosen instruments: I suggest to read this article to have a quick overview. What about options?

In practical terms, let you have $79,610 on your account and want to use this strategy to get exposure towards a volatile asset like SPY with zero risks:
  1. 12 months ago you've bought $80,000 of a short term US Government bond. You've bought @ 99.51;
  2. now the bond expires and you get $(80,000 + 1,200). So you've just earned $1,590;
  3. then you buy an ATM Call expiring at 31-Mar-2020 @ 15.90, which means spending those $1,590 for the longest ATM Call you can afford;
  4. if within a year SPY won't rise, the Call expires worthless, you end up with your starting $79,610 and your loss has been the inflation rate. What a pity, repeat next year;
  5. On the contrary, you exercise the Call, spend about $30,000 (I'm using current values) of your $79,610 account balance, you'll find 100 shares of SPY in the portfolio with a positive performance of x% already accounted;
  6. insert a GTC stop loss order on 100 SPY @ (Call strike) limit price;
  7. enjoy. Maybe repeat with another volatile asset by using leftover $49,000.
Is there any investor who is currently using this strategy?
 
I don't think you really grasp what Taleb was trying to say, albeit it's been a while since I read his barbell writings so maybe I don't have it 100%. He is advocating the thin end of the bar to go into things that have the potential for convexity.. grow a stable base and chase tails with a portion of the proceeds. Logic being that it's hard to price extreme outliers into our systems for a variety of reasons and thus there's almost no way to charge enough for them.

He doesn't like that people set themselves up in life for stable to moderately good outcomes at best case and catastrophic losses at worst. He wants to flip that paradigm around and position so the worst case is moderately bad and the best case is orders of magnitude better than that. SPY ATM call doesn't fit that bill.

There's some good points there that I agree with, but Taleb comes across in a particular manner that never really grabbed me. I agree that if you aim for mediocrity and use the wisdom of the crowd you will get average outcomes. Agree that diversification is very powerful. Agree positive convexity is good. I incorporate these tenants accordingly into my business activities.
 
Magic said:
He wants to flip that paradigm around and position so the worst case is moderately bad and the best case is orders of magnitude better than that. SPY ATM call doesn't fit that bill.
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Well, then replace the ATM Call with a truckload of DOTM options written on your favorite fat tail asset... this doesn't change the barbell principle, you're just amending the risk profile shape.
 
To answer the original question then, I don't think you'll find anyone here holding treasuries and buying deep OTM options. Taleb's strategy sounds nice but he stops short of giving good guidance for realistic implementation.

Using OTM options as the sub-in for convexity is going to give you a large amount of marginally bad outcomes and a few really fat right tails. Even if net expectancy is there; that kind of profile isn't very useful imo. To implement barbell like that you're going to need much higher frequency and already we're getting off the beaten path of what is available to your average investor, which is presumably his target audience.

An 80% anchor is too big not to be a drag on returns unless Taleb gives us more to work with here. Being so concerned about black swans is going to leave one spinning their wheels imo. Better to put another block of seed capital away, accept that tails exist and might occur, and if worst comes to worst just start another round a little more experienced than you were before. Aaron Brown talks a lot more about managing the risks inside the 5% VaR window than preparing for tails. He's more up my alley.
 
Cren1 said:
Hi all, just a quick poll preceded by an explanation for those who don't know what I'm talking about.

This question is for those who don't consider themselves heavy traders but use options like a tool to aid medium and long term investment process; so your goal is not to frantically scalp the Gamma or hedge the Delta of your weekly options the day of an earnings announcement but to build a risky portfolio around the cheapest weighted average prices... then enjoy dividends and positive mark-to-market.

The barbell strategy is more like a philosophy than a real strategy because its principle can be translated differently according to the chosen instruments: I suggest to read this article to have a quick overview. What about options?

In practical terms, let you have $79,610 on your account and want to use this strategy to get exposure towards a volatile asset like SPY with zero risks:
  1. 12 months ago you've bought $80,000 of a short term US Government bond. You've bought @ 99.51;
  2. now the bond expires and you get $(80,000 + 1,200). So you've just earned $1,590;
  3. then you buy an ATM Call expiring at 31-Mar-2020 @ 15.90, which means spending those $1,590 for the longest ATM Call you can afford;
  4. if within a year SPY won't rise, the Call expires worthless, you end up with your starting $79,610 and your loss has been the inflation rate. What a pity, repeat next year;
  5. On the contrary, you exercise the Call, spend about $30,000 (I'm using current values) of your $79,610 account balance, you'll find 100 shares of SPY in the portfolio with a positive performance of x% already accounted;
  6. insert a GTC stop loss order on 100 SPY @ (Call strike) limit price;
  7. enjoy. Maybe repeat with another volatile asset by using leftover $49,000.
Is there any investor who is currently using this strategy?
More...

I'd think it would make more sense not to hold the SPY shares assuming the options expire ITM, lock in your cash profit there and wait for opportunities to enter into more options contracts.

I don't think Taleb's setup works like this though, what I gathered is that he puts a high percentage, 90% if I remember correctly, of his portfolio into Treasuries and pockets the cash from the Treasuries' income, and strategically buys deep ITM options on either indicies or stocks with the 10% remaining. So his max loss can't be more than the difference between the expiring OTM options premiums and the Treasury income, usually less than 7-10%ish assuming all options trades don't work and the only income is the Treasuries. He buys big amounts of deep OTM options at certain times for pennies, looking for the 10% probability home run type of moves.
 
Cren1 said:
Any reference to read something about? Thanks.
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He’s pretty active on Quora, sifting through there will yield a few gems. Got a few books and papers. I really enjoyed Red-Blooded Risk
 
kj5159 said:
I don't think Taleb's setup works like this though, what I gathered is that he puts a high percentage, 90% if I remember correctly, of his portfolio into Treasuries and pockets the cash from the Treasuries' income, and strategically buys deep ITM options on either indicies or stocks with the 10% remaining. So his max loss can't be more than the difference between the expiring OTM options premiums and the Treasury income, usually less than 7-10%ish assuming all options trades don't work and the only income is the Treasuries. He buys big amounts of deep OTM options at certain times for pennies, looking for the 10% probability home run type of moves.
More...
It's more or less the same: investing all the amount and then buying options after bond's expiry date is like investing x% of the balance and at the same time buying options for (1 - x%) where the options premium is equal to the interests that I'll get at bond's expiration.

There's no difference.
 
Magic said:
I don't think you really grasp what Taleb was trying to say, albeit it's been a while since I read his barbell writings so maybe I don't have it 100%. He is advocating the thin end of the bar to go into things that have the potential for convexity.. grow a stable base and chase tails with a portion of the proceeds. Logic being that it's hard to price extreme outliers into our systems for a variety of reasons and thus there's almost no way to charge enough for them.

He doesn't like that people set themselves up in life for stable to moderately good outcomes at best case and catastrophic losses at worst. He wants to flip that paradigm around and position so the worst case is moderately bad and the best case is orders of magnitude better than that. SPY ATM call doesn't fit that bill.

There's some good points there that I agree with, but Taleb comes across in a particular manner that never really grabbed me. I agree that if you aim for mediocrity and use the wisdom of the crowd you will get average outcomes. Agree that diversification is very powerful. Agree positive convexity is good. I incorporate these tenants accordingly into my business activities.
More...
The devil is in the details. But in general I think tails are underpriced.
 
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