BTW, Taleb's strategy of holding 9x% money in cash/Treasuries and betting the rest on out of money options is not new either. I've heard that from some option-trading source ages ago, can't remember where, probably someone here might remember the source (Cramer? - just a guess to stoke the fire ;)). The problem with that strategy is that you can't blow up (unless your currency and/or Treasuries blow up), but you CAN die from thousand paper cuts.
Let's say you'd use this strategy to bet on oil spills. How long would you have lost money until this year's spill occurred? Would your wins recover your losses? Not clear.
Obviously a counter example is Mike Burry's bet on subprime mortgage collapse, but it's kind of a strawman, since apparently he had strong conviction about the event (it was not unpredictable?) and the options (CDS) were terribly cheap (mispriced).
And the jury is really out whether this strategy works long term without deep macro insights, such as Mike Burry's. Assuming that the markets will become more and more volatile, it might. But if the volatility also increases the out-of-money option prices, it might be that the volatility increase won't cover the costs.
It's in some way similar to "Gorilla Game" - the claim that Gorillas were always underpriced was right until it wasn't. Or looking closer to our own field, Buffettology huge-moat companies like KO were underpriced (in 1980's, early 1990's) until they weren't and 10 years of zero returns followed.
It might be that Taleb can avoid overpaying for deep out-of-money options. He argues that they are (always?) underpriced because people price them using too low standard deviation distributions, so tracking the distribution needed for apparent pricing might let him know when not to overpay. Then it would become a question of discipline to sit out situations where available options are too expensive. |
