Black Swan -- a thought experiment

Discussion in 'Trading' started by cdowis, Jul 27, 2008.

  1. cdowis


    I assume that between now and the end of the year, a certain country will attack the nuclear facilities of Iran. To complete the job it will take at least a week.

    I think we can all image how that will affect the markets.

    What strategy can I use now to give myself at least some protecton. Again, I assume that the event date is unknown but will happen before the end of the year.

    The account size is around $20k.
  2. I've always been a fan of the so-called Apocalypse Put.

    Buy some cheap, OTM puts on a few major indexes as a sort of lottery ticket. If the markets tank, you make money on a directional move down, as well as a panic-driven spike in IV.

    While everyone else is sh1ttin' their pants, you're cashing in. Cold, yes, but traders have to be opportunists by nature.

    Another thing to consider is how such an event would affect the USD. Would it go up or down relative to other currencies? (That's a rhetorical question, obviously)
  3. cdowis


    Can you give a specific example. Which strike price, what month.

    Do you buy one every month, or each quarter, for example. As time decay occurs you significantly lose protection.

    Instead of a put, how about a put spread so you can place it closer to the market price.

    You may wake up, and discover that you put is giving you only $100 in protection because of time decay, regardless of the huge downmove.

  4. A black swan is something nobody is expecting. So by definition, this isn't black swan insurance and the markets will likely not respond as aggressively as you imagine. And if they blocked Hormuz, I'd bet it wouldn't be blocked for long. The market would realize this pretty quickly, and the ensuing selloff (in crude) could be ugly.

    With that said, I'd buy some not too far out USO calls (since uso has a chance of bouncing regardless) here as a general hedge, since crude would most likely spike up a bit.

    Read this concerning Iran, however. I recommend it:
  5. Xuanxue


    The insanity that can be found in H.R 362 make viable put plays on Jordanian and Kuwaiti banks and nigh all sectors in Russia and China, imo.


    Whereas nothing in this resolution shall be construed as an authorization of the use of force against Iran: Now, therefore, be it

    Resolved by the House of Representatives (the Senate concurring), That Congress--

    (1) declares that preventing Iran from acquiring a nuclear weapons capability, through all appropriate economic, political, and diplomatic means, is vital to the national security interests of the United States and must be dealt with urgently;

    (2) urges the President, in the strongest of terms, to immediately use his existing authority to impose sanctions on--

    (A) the Central Bank of Iran and any other Iranian bank engaged in proliferation activities or the support of terrorist groups;

    (B) international banks which continue to conduct financial transactions with proscribed Iranian banks;

    (C) energy companies that have invested $20,000,000 or more in the Iranian petroleum or natural gas sector in any given year since the enactment of the Iran Sanctions Act of 1996; and

    (D) all companies which continue to do business with Iran's Islamic Revolutionary Guard Corps;
  6. I agree that a Black Swan is an event that no one anticipates. But I disagree with the argument that the possibility of some kind of attack on Iranian nuke facilities is priced into options. I think what's priced into the market is a perception that this event is possible, but very unlikely. If it happens, clearly prices will reflect the new reality.

    That said, how do you pick options for strike and expiration?

    It's the same old question for choosing any option. A friend of mine asks the following question all the time like a mantra, "What's your prognosis on direction, time and volatility?"

    So answer those questions. How far will the Dow fall in the event of an attack on Iran? What will happen to implied volatility? How fast will these price adjustments occur?

    The market could easily fall 1000 points, but I'd think more like 2000. I think it would happen in 1 day. I think IV (as measured by the VIX) could go from its current absurdly low value of 23% to 50 or 60%.

    Now price out some puts on something super-liquid like the SPY or QQQQ. I think you'd be looking for a 100R move (i.e. 100 times your initial risk). If the market moved as far and as fast as I just speculated, which put would achieve that return?

    I'm not going to answer that question; go look at the option chains and do some what-if scenarios with a risk graph or option pricing tool.

    Imagine buying a far OTM put for $100 and waking up one day and having it be worth $10,000. That's what we're after.
  7. FredBloggs

    FredBloggs Guest

    but who?

    the us is bankrupt and cannot afford another war financially or plitically. that leaves israel. no chance. not on their own.
  8. An attack on Iran is a bull item not a crash catalyst......
  9. jem


    I was wondering the same thing.

    The anticipation of the Iraq war weighed heavily on the markets and the lack of movement hurt my profits.

    Then boom and boom.

    Additionally I remember reading in a book by or about buzzy schwartz he was short going into a conflict in the middle east and then covered into the news and I that was the right move.

    So perhaps we have a Iran conflict premium in the markets right now and the aftermath will be less harmful than the fear.
    Of course, in retaliation, they could lunch missiles at Isreal. If missiles miss the guys who might have taken down the tower 7 will take down the golden dome.

    Isreal will quickly rebuild the temple. The anti christ will come in create peace sit in the temple declare himself God and make everyone wear ID chips to do business. Depending on what type of millenialist you are some of your friends will disappear either before during or after a great conflict...

    There will be a battle with so much blood it will it will flow like a river and you know what happens after that.

    I think I would be short index futures, long ag, long oil and long bomb makers, long international funeral homes and casket makers and then right before the 2nd coming flatten and give everything I had to charity... and if I were really cheeky I would also give some to the Church even though they would not need it much longer.

    By the way I have always thought the best trader in history was the thief on the cross. I suspect my trading plan could be just as good.
  10. The way Taleb prepared for a possible Black Swan was (is?) to take low risk, and the same time take large risk. In other words, he bought T-Bills with his funds, and used the interest earned to pay for the OTM option premium.

    It is still debated on ET as to what kind of return he earned for investors in his fund, using this strategy.
    #10     Jul 28, 2008