Anyone doing tail hedging as recommended by Nassim Taleb

[jnc]

Hi everyone,
In these times of economic uncertainty, Nassim Taleb (of Black Swan fame) is recommending that everyone in the stock market right now should be tail hedging. Are any of you doing that?

A good description of a way to do tail heding is described here: https://thefelderreport.com/2016/08/15/worried-about-a-stock-market-crash-heres-how-you-can-tail-hedge-your-portfolio/

In short, you use 0.5% of your portfolio to purchase protective PUTs that are 30% to 35% out of the money. In a bull market, this strategy is just going to lose you money but in times of great uncertainty, it's a bit of an insurance policy. For instance the fund run by Mark Spitznagel who is referred to in the article I linked (and a protege of Nassim Taleb) uses this strategy and had a 4000% return for the first quarter of 2020 because of the market crash.

I'd be interested in others who are doing this and your experiences.

[struggleism]

I'm a few chapters into Black Swan, and like you I'm wondering how to find a good balance between Taleb's ideas and MMM's 'outrageous optimism'.

[bacchi]

Sorta. I have 2 years of expenses (2021 and 2022) set up as debit call spreads on SPY/ES. The cash is invested in Treasuries maturing when the options expire.

Meaning: If the market goes up, I'll capture some of the gains with the call options. If the market falls, there's no loss (the t-note interest covers the option debit) except for inflation.

Unlike Taleb, I won't make a killing if the market crashes. I will have enough for expenses without selling at a loss.

[vand]

It's something I've considered more and more, but TBH I think the time to do it is when there is a lot of complacency in the market after a long stretch where there hasn't been a significant market correction, implied volatility is low, and that isn't how I'd describe the market today. If we have a blowoff run into the Nov election then it would become much more attractive.

TBH I don't have a good idea of how to get exposure. Can anyone provide tickers/sedols for these funds?

[ChpBstrd]

I regularly hedge with protective puts and collars. These offer protection not only from once-or-twice-in-a-lifetime black swan events, but also routine 20-30% corrections. IMO if your hedge doesn’t kick in until you’re already down 20-40% you’ve already suffered a sequence of returns event that could damage your ability to stay retired. And most people would like to be able to actually retire with sustainable cash flow rather than a bunch of treasuries yielding 1% and a handful of lotto tickets. Far-OTM puts are kind of like buying health insurance with a $25,000 deductible. Better than nothing, but only if you get cancer.

The lazy way to run a collar strategy is ACIO.

[hodedofome]

It's something I've considered more and more, but TBH I think the time to do it is when there is a lot of complacency in the market after a long stretch where there hasn't been a significant market correction, implied volatility is low, and that isn't how I'd describe the market today. If we have a blowoff run into the Nov election then it would become much more attractive.

TBH I don't have a good idea of how to get exposure. Can anyone provide tickers/sedols for these funds?

Agree with this. I started looking for opportunities to add some short exposure at the end of 2019 after seeing how well I did that year. I know from past experience that kind of performance doesn't last very long. I shorted a little bit but March came quicker than I ever imagined. So while I protected the downside a bit it didn't help that much. Agree that the time to look into a strategy like this is after the market is up a good bit and volatility is low/complacent.

If one was to run a strategy like this on their own, in order to get that 4000% return like Spitznagel got, I'm willing to bet you'd need to be an expert at this strategy. I'm sure he also knows how to lose the least amount of money during the times when the strategy isn't optimal. I wouldn't trust myself enough to get enough of a return to cover my losses. Not only that, but a 4000% return on .05% of your money is only a 20% return on the entire account. So if 95% of the account is down over 30%, you haven't covered all your losses. But you've done a lot better than nothing.

We all just need to get rich and send Spitznagel our money after the market is very complacent and volatility is low. And after he does well, we pull the money out and buy in the market at low prices.

[Buffaloski Boris]

People tend to overestimate downside risk. Wouldn’t selling puts have the potential to be a better moneymaker?

[HeadedWest2029]

I've looked into Cambria's TAIL ETF with some interest.  It popped 40% during the market downturn.  I think insurance is a good way of looking at it.  You have to stare at it losing money for potentially years on end.  Overall, you can also expect it to lose money over time, but with a small allocation it could help round out volatility a little bit.  Having said all that, I have years of living expenses in bonds and cash so I've made peace with just living off those during a downturn. 

AQR has done a few whitepapers on the topic
https://www.aqr.com/Insights/Research/White-Papers/Chasing-Your-Own-Tail-Risk-Revisited
https://www.aqr.com/Insights/Research/White-Papers/Tail-Risk-Hedging-Contrasting-Put-and-Trend-Strategies

[vand]

A good read here on the volatility trade:
https://static1.squarespace.com/static/5581f17ee4b01f59c2b1513a/t/59e8a9b0e9bfdfb287faa3d2/1508420022032/Artemis_Volatility+and+the+Alchemy+of+Risk_2017.pdf

[vand]

I've looked into Cambria's TAIL ETF with some interest.  It popped 40% during the market downturn.  I think insurance is a good way of looking at it.  You have to stare at it losing money for potentially years on end.  Overall, you can also expect it to lose money over time, but with a small allocation it could help round out volatility a little bit.  Having said all that, I have years of living expenses in bonds and cash so I've made peace with just living off those during a downturn. 

AQR has done a few whitepapers on the topic
https://www.aqr.com/Insights/Research/White-Papers/Chasing-Your-Own-Tail-Risk-Revisited
https://www.aqr.com/Insights/Research/White-Papers/Tail-Risk-Hedging-Contrasting-Put-and-Trend-Strategies

A tail risk fund that only gains 40% during a market meltdown of over 30% seems like a terrible play risk/reward play to me. I'd want something close to 400-4000%. The idea is that you only put in a tiny fraction of your portfolio, say 2% or less. With the Cambria fund you'd need to put half your portfolio in to get the same protection.. at the cost of destroying your long term returns.

[HeadedWest2029]

I agree that 4,000% is better than 40%.  I don't know a ton about Universa Investments because I don't have access to hedge funds, but I'm guessing it A) is dripping with management fees B) would not be interested in taking my measly 5% of the portfolio and C) can only achieve 4,000% returns by under-performing to the extreme during times without volatility or have a kick-ass crystal ball to short the market via discretionary active management.

I mean, I know they did it (or say they did), but I don't know much about the underlying make-up of the fund

[bacchi]

https://www.investopedia.com/news/black-swan-investors-lose-big-stocks-thrive/ (06/25/2019)

Indeed, after hitting peak performance in September 2011, these funds have fallen by about 55%

Yeah, not so much for cash flow. Sure, Universa made up for it this spring but losing half of your investment while your other investments are going gangbusters would be a bitter pill to swallow.

[hodedofome]

https://www.investopedia.com/news/black-swan-investors-lose-big-stocks-thrive/ (06/25/2019)

Indeed, after hitting peak performance in September 2011, these funds have fallen by about 55%

Yeah, not so much for cash flow. Sure, Universa made up for it this spring but losing half of your investment while your other investments are going gangbusters would be a bitter pill to swallow.

Yeah you really have to time these funds. Taleb got lucky in that he wasn't trading for very long before 1987 hit and he became wealthy overnight. After an event like 2008 or 2020, it's years before you need the strategy again.

[hodedofome]

Forgot about this, I don't subscribe but I've followed it for a while. Looks like it does better than the Taleb strategy in the off years while not doing quite as well during the big crash. https://tradingvolatility.collective2.com/details/100314882

More details on his website here: http://www.tradingvolatility.net/p/home_3.html

[ChpBstrd]

I've looked into Cambria's TAIL ETF with some interest.  It popped 40% during the market downturn.  I think insurance is a good way of looking at it.  You have to stare at it losing money for potentially years on end.  Overall, you can also expect it to lose money over time, but with a small allocation it could help round out volatility a little bit.  Having said all that, I have years of living expenses in bonds and cash so I've made peace with just living off those during a downturn. 

AQR has done a few whitepapers on the topic
https://www.aqr.com/Insights/Research/White-Papers/Chasing-Your-Own-Tail-Risk-Revisited
https://www.aqr.com/Insights/Research/White-Papers/Tail-Risk-Hedging-Contrasting-Put-and-Trend-Strategies

A tail risk fund that only gains 40% during a market meltdown of over 30% seems like a terrible play risk/reward play to me. I'd want something close to 400-4000%. The idea is that you only put in a tiny fraction of your portfolio, say 2% or less. With the Cambria fund you'd need to put half your portfolio in to get the same protection.. at the cost of destroying your long term returns.

How would you set up a fund to generate those kinds of outcomes though?

Bearish futures contracts are out of the question because they would commit your fund to “blow up” scale losses when the market’s direction is up. One cannot say they are only allocating 2% of their portfolio to a product with potentially much greater losses. That leaves options, half of which expire worthless.

The most leveraged bet I could think of, at the cheapest long-term price, would be to buy puts on the S&P 500 at the 700 strike (current is 3259) with an expiration of December 16, 2022 (2.4 years) for about $700 per contract (tied to 100 units of the index). So you have some serious leverage with a break even at an S&P 79% below today’s prices. Of course, this investment could quadruple if a downturn or volatility event occurred with plenty of time remaining, but it has a near certainty of being a 100% loss in the long run. Also, the protection might be lacking in a slow decline scenario or a market that doesn’t have its 50% crash until soon before the option’s expiration date! To mitigate this risk you’d probably roll annually at a loss of maybe half the option’s value or 1% of the portfolio.

But still, a 2% allocation on this wild bet would probably not save one’s portfolio from a 50% crash or even a decade long depression.

[MDM]

A good description of a way to do tail heding is described here: https://thefelderreport.com/2016/08/15/worried-about-a-stock-market-crash-heres-how-you-can-tail-hedge-your-portfolio/

Why ‘Tobin’s Q’ Should Make You More Cautious Towards The Stock Market Today – The Felder Report was published in May 2016.  Four years later (May 2020), the Annualized S&P 500 Return (Dividends Reinvested) has been 11.1%.

May not mean anything beyond "past performance does not necessarily predict future results."

[vand]

I've looked into Cambria's TAIL ETF with some interest.  It popped 40% during the market downturn.  I think insurance is a good way of looking at it.  You have to stare at it losing money for potentially years on end.  Overall, you can also expect it to lose money over time, but with a small allocation it could help round out volatility a little bit.  Having said all that, I have years of living expenses in bonds and cash so I've made peace with just living off those during a downturn. 

AQR has done a few whitepapers on the topic
https://www.aqr.com/Insights/Research/White-Papers/Chasing-Your-Own-Tail-Risk-Revisited
https://www.aqr.com/Insights/Research/White-Papers/Tail-Risk-Hedging-Contrasting-Put-and-Trend-Strategies

A tail risk fund that only gains 40% during a market meltdown of over 30% seems like a terrible play risk/reward play to me. I'd want something close to 400-4000%. The idea is that you only put in a tiny fraction of your portfolio, say 2% or less. With the Cambria fund you'd need to put half your portfolio in to get the same protection.. at the cost of destroying your long term returns.

How would you set up a fund to generate those kinds of outcomes though?

Bearish futures contracts are out of the question because they would commit your fund to “blow up” scale losses when the market’s direction is up. One cannot say they are only allocating 2% of their portfolio to a product with potentially much greater losses. That leaves options, half of which expire worthless.

The most leveraged bet I could think of, at the cheapest long-term price, would be to buy puts on the S&P 500 at the 700 strike (current is 3259) with an expiration of December 16, 2022 (2.4 years) for about $700 per contract (tied to 100 units of the index). So you have some serious leverage with a break even at an S&P 79% below today’s prices. Of course, this investment could quadruple if a downturn or volatility event occurred with plenty of time remaining, but it has a near certainty of being a 100% loss in the long run. Also, the protection might be lacking in a slow decline scenario or a market that doesn’t have its 50% crash until soon before the option’s expiration date! To mitigate this risk you’d probably roll annually at a loss of maybe half the option’s value or 1% of the portfolio.

But still, a 2% allocation on this wild bet would probably not save one’s portfolio from a 50% crash or even a decade long depression.

Most options expire worthless. That's the nature of them - they're speculative trading instruments with no intrinsic value.

so, absent a crash, I'd expect these fund to be declining 95%+ a year. It's not something you can just buy as a one-off. You'd have to rebalance periodically and commit new capital to the fund each year, same as having to renew your home insurance premium every year.

I'd also have questions about liquidity in these funds. Are we 100% certain than, if the market falls 60% and these funds do make their 60000% gains or whatever, that we can easily cash that in at the click of a mouse? There would be nothing worse than the fund being closed to outflows as the market was at its most crazy and only being allowed to withdraw your funds after everything died down and the fund has lost 80% of those gains.

[talltexan]

I've dabbled with options, but there are a couple of things that make it more difficult than buy/hold investing:

• The extra knob of timing: you're taking a position on time as well as on price...more dimensions means more ways you can be wrong
• The tendency to bid for a margin of safety: cautious limit orders mean you miss out when the market has momentum, and get caught exposed on the way down.
• The sneaking suspicion that the counterparty knows more than I do.
• The large lot size: I sometimes make the honest mistake of forgetting to multiply by 100 when calculating where I need to be, and many places where I'd like to go with options mean I'm working in chunks of $10,000 or more very quickly.
• I get discouraged by having things go wrong and am not certain enough in the strategy that I know I will persist through several years of losing trades.

I find Taleb's claims that variance in the world is underpriced pretty persuasive. His strategy typically involves arranging things for minimal downside and large upside, but you don't necessarily know where that upside will come from.

[mjchamb]

I've looked into Cambria's TAIL ETF with some interest.  It popped 40% during the market downturn.  I think insurance is a good way of looking at it.  You have to stare at it losing money for potentially years on end.  Overall, you can also expect it to lose money over time, but with a small allocation it could help round out volatility a little bit.  Having said all that, I have years of living expenses in bonds and cash so I've made peace with just living off those during a downturn. 

AQR has done a few whitepapers on the topic
https://www.aqr.com/Insights/Research/White-Papers/Chasing-Your-Own-Tail-Risk-Revisited
https://www.aqr.com/Insights/Research/White-Papers/Tail-Risk-Hedging-Contrasting-Put-and-Trend-Strategies

A tail risk fund that only gains 40% during a market meltdown of over 30% seems like a terrible play risk/reward play to me. I'd want something close to 400-4000%. The idea is that you only put in a tiny fraction of your portfolio, say 2% or less. With the Cambria fund you'd need to put half your portfolio in to get the same protection.. at the cost of destroying your long term returns.

How would you set up a fund to generate those kinds of outcomes though?

Bearish futures contracts are out of the question because they would commit your fund to “blow up” scale losses when the market’s direction is up. One cannot say they are only allocating 2% of their portfolio to a product with potentially much greater losses. That leaves options, half of which expire worthless.

The most leveraged bet I could think of, at the cheapest long-term price, would be to buy puts on the S&P 500 at the 700 strike (current is 3259) with an expiration of December 16, 2022 (2.4 years) for about $700 per contract (tied to 100 units of the index). So you have some serious leverage with a break even at an S&P 79% below today’s prices. Of course, this investment could quadruple if a downturn or volatility event occurred with plenty of time remaining, but it has a near certainty of being a 100% loss in the long run. Also, the protection might be lacking in a slow decline scenario or a market that doesn’t have its 50% crash until soon before the option’s expiration date! To mitigate this risk you’d probably roll annually at a loss of maybe half the option’s value or 1% of the portfolio.

But still, a 2% allocation on this wild bet would probably not save one’s portfolio from a 50% crash or even a decade long depression.

From what I've been able to find out (which is difficult given the nature of hedge funds) they are using neutral options strategies to fund the purchase of OTM puts on the market and/or calls on VIX/VXX. The source said ATM butterflies are the strategy they use, but one could also use iron condors, or anything else that benefits from a neutral market. As far as how far out of the money to buy the long calls or puts, how many to purchase, when to take profits...that's why they run a hedge fun with a genius mathematician as the CSO.

I often have thought about doing something similar at the retail level, but funding the purchase of long options with the sale of covered calls against VTI, as it would generate more profits than the spreads (but make you subject to more upside risk, I know).

[ChpBstrd]

I've looked into Cambria's TAIL ETF with some interest.  It popped 40% during the market downturn.  I think insurance is a good way of looking at it.  You have to stare at it losing money for potentially years on end.  Overall, you can also expect it to lose money over time, but with a small allocation it could help round out volatility a little bit.  Having said all that, I have years of living expenses in bonds and cash so I've made peace with just living off those during a downturn. 

AQR has done a few whitepapers on the topic
https://www.aqr.com/Insights/Research/White-Papers/Chasing-Your-Own-Tail-Risk-Revisited
https://www.aqr.com/Insights/Research/White-Papers/Tail-Risk-Hedging-Contrasting-Put-and-Trend-Strategies

A tail risk fund that only gains 40% during a market meltdown of over 30% seems like a terrible play risk/reward play to me. I'd want something close to 400-4000%. The idea is that you only put in a tiny fraction of your portfolio, say 2% or less. With the Cambria fund you'd need to put half your portfolio in to get the same protection.. at the cost of destroying your long term returns.

How would you set up a fund to generate those kinds of outcomes though?

Bearish futures contracts are out of the question because they would commit your fund to “blow up” scale losses when the market’s direction is up. One cannot say they are only allocating 2% of their portfolio to a product with potentially much greater losses. That leaves options, half of which expire worthless.

The most leveraged bet I could think of, at the cheapest long-term price, would be to buy puts on the S&P 500 at the 700 strike (current is 3259) with an expiration of December 16, 2022 (2.4 years) for about $700 per contract (tied to 100 units of the index). So you have some serious leverage with a break even at an S&P 79% below today’s prices. Of course, this investment could quadruple if a downturn or volatility event occurred with plenty of time remaining, but it has a near certainty of being a 100% loss in the long run. Also, the protection might be lacking in a slow decline scenario or a market that doesn’t have its 50% crash until soon before the option’s expiration date! To mitigate this risk you’d probably roll annually at a loss of maybe half the option’s value or 1% of the portfolio.

But still, a 2% allocation on this wild bet would probably not save one’s portfolio from a 50% crash or even a decade long depression.

From what I've been able to find out (which is difficult given the nature of hedge funds) they are using neutral options strategies to fund the purchase of OTM puts on the market and/or calls on VIX/VXX. The source said ATM butterflies are the strategy they use, but one could also use iron condors, or anything else that benefits from a neutral market. As far as how far out of the money to buy the long calls or puts, how many to purchase, when to take profits...that's why they run a hedge fun with a genius mathematician as the CSO.

I often have thought about doing something similar at the retail level, but funding the purchase of long options with the sale of covered calls against VTI, as it would generate more profits than the spreads (but make you subject to more upside risk, I know).

Unfortunately VTI has relatively weak options liquidity compared to, say, SPY. The bid-ask spread would eat you alive, and the lack of LEAPS is limiting.

What you were looking at doing is a collar strategy. A collar can save your arse in a downturn, but at the price of missing most of the gains in big years like 2019. They are relatively easy to understand, low maintenance, and can be done so that the net cost is zero. I would argue that a 100% collared stock portfolio is safer than a 60% bond 40% stock portfolio because it allows you to dodge the damage from all SORR events beyond your pre-set loss tolerance. Additionally, if your IPS requires you to sell your suddenly appreciated options in the event of a downturn of X% and go all-long, you have a very good chance of outperforming the market. The last couple of short term V shaped corrections are textbook examples of when that worked well.

[mjchamb]

I've traded collars before, but found that "affordable" downside protection is often so far out of the money that the profits from multiple months of call premiums gets wiped out by one bad month, especially if your underlying drops but doesn't exceed your puts. I'm referring to more of a neutral strategy that funds long, far OTM positions that represent rare events.

Agree that VTI isn't liquid enough, but I use it without much difficulty for simple covered call selling.

What is SORR an acronym for? I'm unfamiliar.

[bacchi]

What is SORR an acronym for? I'm unfamiliar.

Sequence of Returns Risk

For FIRE people, it's the first ~5 years of being fired where low returns will crater the portfolio. C.f., retiring in 1966.

[ChpBstrd]

I've traded collars before, but found that "affordable" downside protection is often so far out of the money that the profits from multiple months of call premiums gets wiped out by one bad month, especially if your underlying drops but doesn't exceed your puts. I'm referring to more of a neutral strategy that funds long, far OTM positions that represent rare events.

Interestingly, the theoretical literature says that call options are usually or at least should be more expensive than put options a comparable distance from the current price and after adjusting for the dividends one can receive with a protective put but not with a call + cash. This is because, quite simply, the market usually goes up, and this expectation affects how much implied volatility other people are willing to pay for. If you were to buy an OTM call and an OTM put with a year or two duration, which would be more likely to be ITM at expiration? The call of course.

In reality though, puts are often more expensive because investments like VTI or SPY pay a small dividend and because of volatility skew, which is fascinating stuff.

https://www.investopedia.com/terms/v/volatility-skew.asp

One sneaky way to avoid the dividend penalty and still collect the dividend would be to collar your SPY by selling a call on SPY but buying a put on the S&P500 index. SPY just happens to be about 1/10th of the S&P500 so the math is easy if you have 1000 shares of SPY. Just sell 10 SPY calls and buy 1 S&P put and you are collared. For example, Yahoo Finance lists the last price for a 3000 strike S&P500 put at $282, and a 300 strike SPY put at $28.71.

[hodedofome]

If I was forced to do a tail risk on my portfolio, I would do a 3rd Taleb style, a third with a VXX strategy like I posted above, and a third with a trend following managed futures strategy. Any of those strategies can have a string of bad years, but hopefully they wouldn’t all have a string of bad years together.

[mjchamb]

I've traded collars before, but found that "affordable" downside protection is often so far out of the money that the profits from multiple months of call premiums gets wiped out by one bad month, especially if your underlying drops but doesn't exceed your puts. I'm referring to more of a neutral strategy that funds long, far OTM positions that represent rare events.

One sneaky way to avoid the dividend penalty and still collect the dividend would be to collar your SPY by selling a call on SPY but buying a put on the S&P500 index. SPY just happens to be about 1/10th of the S&P500 so the math is easy if you have 1000 shares of SPY. Just sell 10 SPY calls and buy 1 S&P put and you are collared. For example, Yahoo Finance lists the last price for a 3000 strike S&P500 put at $282, and a 300 strike SPY put at $28.71.

That would be a clever way to avoid the "dividend penalty", but the market makers appear to be way ahead of you. I pulled up the SPY and S&P 500 options chains just now and a Dec 18 '20 call is 16.75/16.84 (bid/ask) for SPY and 168.70/169.00 for the S&P 500, so it looks like the actual S&P call would pay a bit more than 10x SPY calls, even with a discount for future dividends included.

I was referring less to the put call parity and more to the practical idea that if you are selling call options for income, a tight collar is a nice hedge but gives you very little premium on the call side once you pay for the put. Thus defeating the purpose of generating income.

I was buying puts as a type of "insurance" in case of a gap down in stock price. As such, the puts I was buying were typically a few strikes below ATM, where I was selling the call. So if the underlying gapped down I would be protected from catastrophe, but the loss on stock would end up eating away lots of call premiums.