Taleb's barbell strategy

[birzos]

It's highly efficient in high risk cycles and treads water in low risk cycles, as we're moving from low risk to high risk it has value. Taleb has been through more extreme sigma events than most people in life, so he understands when they occur they are highly rewarding with limited downside, but you have to dodge the noise between events.

As most people in life stay around the neutral distribution they prefer the medium risk fully exposed route, it generates income when it works and loses you your shirt when it doesn't. But you'd have to understand extreme events to see the difference, and most peoples concept of extreme is a Caribbean holiday in the sun for those that know. Conclusion, it's all about the timing, the more patient you are the more extreme the returns.

 

[ET180]

Not all products have strong correlation when the markets fall apart. One way to gain a little protection is to get long volatility when gaining long exposure is cheap (such as now). Kinda like driving a car...there are times when you can go above the speed limit and there are times when you should be driving well below the speed limit. A good driver does not need speed limits. He or she knows the performance / physics of his or her vehicle and can adapt to road conditions in order to minimize travel time as much as possible (or maximize efficiency if that's his / her goal). Investing is similar. A good investor does not need to follow rules for capital allocation. He or she has a good feel for how much capital (speed) is prudent to risk at any given time.

 

[fyretrading]

If only we had 12x etfs like in sweden

 

[Apollonius]

AT: But meanwhile you could sell near-the-money options?

NNT: Yes, but it’s a lot of work. Now I have an economic interest in other traders (through the Empirica fund) that sell nearthe- money options.

AT: Why is it so much work?

NNT: If you want to place butterflies in 500 securities, it’s a lot of work because you have to adjust them dynamically. But if you want to buy strangles in 500 different securities, it’s a nobrainer. (A butterfly options strategy sells options with strike prices near the current price and buys options further away from the money to protect them. A long strangle buys options both above and below the market in hopes that the market will exceed those strike-price thresholds by expiration. See “Long butterflies”)

If you care about performance, you should short at-themoney options, which expire and have very unstable deltas. Sometimes they bite you at expiration, so you have to monitor them. The amount of labor involved in strategies that have both long and short options is astronomically higher than just buying options.

AT: So the long out-of-the-money options aren’t as risky because their gamma — delta’s rate of change — isn’t that high?

NNT: Exactly. When they pay off, [the reward] is huge. But when you’re selling options, you need a lot of traders. For example, two or three traders can trade long out-of-the-money options on 500 instruments, but when you’re using long and short strategies, two or three traders can only monitor 50 or 60 positions. We invest in traders who sell at-the-money options, and we concentrate on just buying the “wings” (the out-of-themoney puts and calls of the butterfly position).

AT: Are your other traders placing butterfly positions or simply selling ATM options?

NNT: I call it a mixed strategy. Some of the traders sell at-themoney options and buy the wings (creating a complete butterfly position), and some just sell these options, while we buy the wings for them. But you need a lot more that just a butterfly position. I buy butterflies and also buy a lot more wings.

AT: What’s the benefit to this approach?

NNT: A butterfly position allows you to wait a lot longer for the wings to become profitable. In other words, a strategy that involves a butterfly allows you to be far more aggressive [when buying out-of-the-money options].

When you short near-the-money options, they bring in a lot of cash, so you can afford to spend more on out-of-the-money options. You can do a lot better as a spread trader.

You can make some money in options, but the larger the deviation, the less we understand. Secondly, it doesn’t mean all out-of-the-money options are priced wrong.

 

[ironchef]

I am a fan of Taleb.

I read his book on Antifragile. Very thought provoking, very thoughtful and helpful to me. For me how to trade options with the understanding of convexity and optionality is eye opening. Martinghoul and Maverick74 both mentioned the nonlinear nature of options in their old posts but the concept went over my head until I read his book. To me it is more important that arguing about the risk free side of his barbell strategy.

Cheers.

 

[Daal]

I am a fan of Taleb.

I read his book on Antifragile. Very thought provoking, very thoughtful and helpful to me. For me how to trade options with the understanding of convexity and optionality is eye opening. Martinghoul and Maverick74 both mentioned the nonlinear nature of options in their old posts but the concept went over my head until I read his book. To me it is more important that arguing about the risk free side of his barbell strategy.

Cheers.

I agree, Antifragile is great. I think Book Six (The Medical Chapters) is outstanding. I just feel that Taleb could be doing a better job at explaining some things

 

[ironchef]

I agree, Antifragile is great. I think Book Six (The Medical Chapters) is outstanding. I just feel that Taleb could be doing a better job at explaining some things

He wrote with a chip on his shoulder for some reason. I just ignored those flaming statements against the establishments and tried to understand the wisdoms of what he wrote.

I read and enjoyed your posts. You had some out of the box thinkings too.

Regards,

 

[Butterball]

Anyone remember Taleb's hot tip: every trader should own deep OTM puts on US bonds? He was on CNBC or Bloomberg I remember: "You buy puts, every month. With a small amount. Then next month, again with a small amount. And you keep repeating. Every month. Very simple. America is bankrupt, and when bonds crashing you will make very very big return!!!! Simple!"

There's your barbell. You lost 1% x 60 months = -45% total return and on the flipside of the barbell you made 0% on your 90% worth of low-risk asset. Great success! How many naive traders have lost a good chunk of their nest-egg following this idiot?

 

[Maverick74]

Anyone remember Taleb's hot tip: every trader should own deep OTM puts on US bonds? He was on CNBC or Bloomberg I remember: "You buy puts, every month. With a small amount. Then next month, again with a small amount. And you keep repeating. Every month. Very simple. America is bankrupt, and when bonds crashing you will make very very big return!!!! Simple!"

There's your barbell. You lost 1% x 60 months = -45% total return and on the flipside of the barbell you made 0% on your 90% worth of low-risk asset. Great success! How many naive traders have lost a good chunk of their nest-egg following this idiot?

No, that is not what he said. Almost all his OTM structures are financed. I do this all the time, in fact almost every month. You lose maybe 5% and possible make 50 to 100 times that if you are right. It's all about asymmetry. I do agree with you though that retail people should not do this as most retail people don't even know what asymmetry means.

 

[Sig]

No, that is not what he said. Almost all his OTM structures are financed. I do this all the time, in fact almost every month. You lose maybe 5% and possible make 50 to 100 times that if you are right. It's all about asymmetry. I do agree with you though that retail people should not do this as most retail people don't even know what asymmetry means.

In my experience you lose 5% with a probability of 99% and make 100% with a probability of 1% giving you an expected value of less than 0. It's not about understanding assymetry, it's about finding mispriced securities which is far harder for us mere mortals than you let on (I'm purposely goading you to provide such an example, if it isn't obvious!)