Black Swan Hedging

VXX Calls or SPY Puts

  • SPY Puts

    Votes: 7 50.0%

  • VXX Calls

    Votes: 3 21.4%

  • Other- Comment below

    Votes: 4 28.6%
  • Total voters
    14
T

TazTheLaz

In Nassim Taleb's book 'The Black Swan' he explains that there are many events, such as the 9/11 Terrorist Attacks or the Coronavirus Pandemic that cannot be easily predicted, but still have massive effects on the economy or politics.

That being said, I would like to hedge against these events. I have two different ideas for what to do:

  • SPY Puts
    • In 2020, the S&P 500 dropped 35% at its very bottom.
    • A put option with a strike of 375, premium of 9 cents per share, and expiry in 2 weeks yields a 77,000% gain ($6,900 per contract) if the S&P were to drop 35% (Assuming ceteris paribus)
    • $9 is the maximum amount at risk.
  • VXX Calls
    • VXX Rose 440% during the stock market crash.
    • A call option with a 50 strike, premium of 9 cents per share, and same expiry yields a ~50,000% gain ($4,500 per contract) if VXX were to perform 440% (Again, assuming ceteris paribus)
    • Same amount is at risk.
  • These trades will be continuously rolled until the black swan event happens.
 
Just a put or a call option at reasonable strikes against the underlying that you are investing to render it delta-neutral will be more than enough. No point in investing in these hedging strategies on their own. They are not that effective tbh in terms of hedging purposes. There is no way that SPY will drop 35% or VXX will go up to 50. If they do, your underlying will be losing lot more than what you are hedging and you won't be getting that much back from these hedging strategies. If you want to hedge more effectively then you will have to invest significantly more in these hedging strategies against black swan events that happen really once in a blue moon.

Taleb's idea of hedging against tail risk is a noble idea but is really expensive to implement irl and is really not that worth it imo.
 
Hedging always has a cost. To help offset these costs, Taleb used to support the idea of buying tbills/bonds, and using the interest income to pay for the OTM options. This was his barbell strategy, i.e. take no risk and take enormous risk at the same time.

I really don't know if he still uses or touts this strategy anymore.
 
What is the reason for hedging? The events that you listed were good times to go long stocks and short volatility. Are you managing other people’s money?
 
qlai said:
What is the reason for hedging? The events that you listed were good times to go long stocks and short volatility. Are you managing other people’s money?
More...

I just don't want to lose tons of money to the unexpected.
 
qlai said:
What is the reason for hedging? The events that you listed were good times to go long stocks and short volatility. Are you managing other people’s money?
More...
However, an entirely possible scenario is the market drops 35%, you buy, it continues to drop to 50% from the high. The market then spends the next twenty years going back up to your breakeven price.

If you can potentially wait half of your remaing life waiting for prices to recover, good on you. Others can't, so they feel the need to hedge. As I mentioned though, hedging has a cost.
 
panzerman said:
Hedging always has a cost. To help offset these costs, Taleb used to support the idea of buying tbills/bonds, and using the interest income to pay for the OTM options. This was his barbell strategy, i.e. take no risk and take enormous risk at the same time.

I really don't know if he still uses or touts this strategy anymore.
More...

Yeah but t-bills/bonds have their own risk, albeit small but they are not entirely risk-free so how are you going to hedge against that? I mean the key to managing risk is not to completely eliminate it but to control it to a range that is within your capacity and will be less than the potential return you can earn from your investment.
 
TazTheLaz said:
I just don't want to lose tons of money to the unexpected.
More...

LOL... yeah none of us want that!

Taleb didn't write as much about his actual implementation of these protections and his performance over long periods of time. From what I understand, he lost a fair amount of money waiting to be right for some years. When he was right of course the ship came in, but you have to think about what you are really trying to achieve. It's really sexy to look at those super cheap puts that would be up 77,000% during a free fall, but they are that cheap for a really good reason - you could well buy them for decades and never cash them in.

In my opinion, there are lots of other (more boring) strategies that serve to mitigate risk more meaningfully and thoroughly while keeping your account headed in the right direction.
 
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