Comments on: Of Black Swans and Put Options http://www.onemint.com/2009/06/26/of-black-swans-and-put-options/ Helps You Make Better Financial Decisions Sat, 11 Feb 2012 17:32:04 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: Manshu http://www.onemint.com/2009/06/26/of-black-swans-and-put-options/comment-page-1/#comment-22873 Manshu Sun, 28 Jun 2009 17:27:53 +0000 http://www.onemint.com/?p=2136#comment-22873 I did try it out and discovered what you are saying Mark. I think at about Jan last year, I bought a Put which expired in three months and was out of the money. At the end of three months it expired worthless. And I was wondering what to do next. Should I go ahead and get another one or just let it be. In the end I just left it because as they say, the market can stay irrational longer than you can stay solvent. I did try it out and discovered what you are saying Mark. I think at about Jan last year, I bought a Put which expired in three months and was out of the money. At the end of three months it expired worthless. And I was wondering what to do next.

Should I go ahead and get another one or just let it be. In the end I just left it because as they say, the market can stay irrational longer than you can stay solvent.

]]> By: Mark Wolfinger http://www.onemint.com/2009/06/26/of-black-swans-and-put-options/comment-page-1/#comment-22803 Mark Wolfinger Sun, 28 Jun 2009 02:06:59 +0000 http://www.onemint.com/?p=2136#comment-22803 It's not easy (to pull the trigger) buying cheap put options. But even if you do, the black swan event that your dad suggests would arrive on an annual basis is not what happens in the real world. Sure the market may decline, but if you buy a put that's rally cheap, it will probably remain worthless unless there is a large, sudden decline. 5% is not enough. And 10% may not be good enough either. Right now SPY is 92. The Jul 83 put (10% out of the money) is cheap: 29 cents. If SPY were to drop to 83 Monday, the put becomes at the money. The current at the money put, the Jul 92 put, is currently $2.10. If the 10% drop does occur, implied volatility would rise, and the (now at the money) Jul 83 put would be higher than $2.10. Let's be generous and suppose it's $5.80 - or worth 20x the cost. That's a very nice profit. But how many would you have to own to see 'gold.' A profit of $550 on a one lot is not enough to offset losses for a normal, long-only, portfolio. I'm not knocking the idea. Just pointing out that you have to own a bunch of these puts, and most people would not be comfortable spending too much money on this longshot. Especially month after month. I am not knocking Taleb and his work. But the more likely outcome would be for the market to decline by less than 10% and to take a longer time to do it - most years. When that happens, you lose on both the puts and your portfolio. It's great to own end-of-world-as-we-know-it insurance. After all, 1987, 9/11/01, 2000, and 2008 did happen. And will happen again. But it is expensive to own enough puts. Your last line says it all: You are not guaranteed to make a killing. Good post. It’s not easy (to pull the trigger) buying cheap put options. But even if you do, the black swan event that your dad suggests would arrive on an annual basis is not what happens in the real world. Sure the market may decline, but if you buy a put that’s rally cheap, it will probably remain worthless unless there is a large, sudden decline.

5% is not enough. And 10% may not be good enough either.

Right now SPY is 92. The Jul 83 put (10% out of the money) is cheap: 29 cents.
If SPY were to drop to 83 Monday, the put becomes at the money. The current at the money put, the Jul 92 put, is currently $2.10. If the 10% drop does occur, implied volatility would rise, and the (now at the money) Jul 83 put would be higher than $2.10.

Let’s be generous and suppose it’s $5.80 – or worth 20x the cost. That’s a very nice profit. But how many would you have to own to see ‘gold.’ A profit of $550 on a one lot is not enough to offset losses for a normal, long-only, portfolio.

I’m not knocking the idea. Just pointing out that you have to own a bunch of these puts, and most people would not be comfortable spending too much money on this longshot. Especially month after month.

I am not knocking Taleb and his work. But the more likely outcome would be for the market to decline by less than 10% and to take a longer time to do it – most years. When that happens, you lose on both the puts and your portfolio.

It’s great to own end-of-world-as-we-know-it insurance. After all, 1987, 9/11/01, 2000, and 2008 did happen. And will happen again. But it is expensive to own enough puts. Your last line says it all: You are not guaranteed to make a killing.

Good post.

]]>