taleb question

Discussion in 'Options' started by nravo, May 8, 2005.

  1. nravo


    Ok, I'm sure you guys are familiar with Empirica Capital and its strategy of t-bills and using the coupons to buy long options. Ok, let's say that for $1 million, EC pulls in 45k a year income, a 4.5 percent return. And lets say that spreading his bets, he doubles that or even triples it one year. Wow that like a 9 percent to 13 percent return. Ok, I guess. And quite good given the market risk on the downside - nil. (Forget inflation, bond market crash, etc. for a second.) But if this is a good year and there are many years where they entire 45k is frittered away on options that expire worthless, what kind of long-term gain are we talking here? Like merger arb returns, slightly better than bonds? Is this fund just for people loooking to diversify, correlate away, preserve capital and get lucky occassionally? I fail to see how this could generate substantial positive returns over time. Anyone know the details of what Taleb does and what his returns are like?
  2. the fund has been terminated, and he is on sabatical.
  3. nravo


    Interesting. Why?
  4. Here you go:

    NNT’s Sabbatical from Empirica
    People keep asking me why I am taking a sabbatical. Facts: I returned between 300M and 400M to investors under the official reason of “wanting to take a sabbatical” (in fact we turned down cumulatively an equivalent sum over the past two years as Empirica rarely took funds under the protocol). “Sabbatical” has the Semitic root Shin-Bet-Aleph, possibly the same origin as “seven” –my last sabbatical ended exactly six years ago; is there a magic number?. Project: “to do pure thinking” for close to a year; completely stripped of any active business obligations to investors, free to trade Empirica’s portfolio in what manner I wish and not trade for as long as I feel[1].

    There is something beyond the mere self-granting of a sabbatical. I found it exhilarating to return the funds to their owners for no particular reason, nothing other than this feeling of control (few people have the guts to tear themselves away from something, they wait for events to control their choices). As a Stoic I should accept that the feeling of being in control of one’s environment (making the random internally more deterministic) does not require such action ( a true Stoic would find it repelling to earn money beyond one’s own subsistence but that’s another discussion); but, as a human being endowed with a hormonal system, I feel elation at exercising my own choices. Walking away from money (albeit temporarily) is far more elevating, and, even in the narrowly hedonic sense, it is far preferable to striving for it –just like inverse greed. Saying “enough for me” gives a different feeling than being told “enough for you”. Someone explained to me that turning down “such free money” is like throwing money in the garbage can, which might be right for a neoclassical economist, but not for someone who knows something about human nature. Kahneman and Tversky studied the “loss aversion” ingrained in humans: a loss is not (both qualitatively and quantitatively) the same as a negative profit, an error by commission is not the same as an error by omission (preventing deaths is not the same as saving lives); to that I have to add that money turned down is not the same as money given away. This is the topic of the third volume of the uncertainty trilogy, which I find more fun to write than The Black Swan [2] (mostly because of the return of Nero Tulip). The subject is about Stoicism, and the inseparability of utility and probability (i.e., chance and happiness are too intertwined). This merges the philosophies of randomness with the new topics of economics of happiness and neuroeconomics (title: Chance and the Logic of Happiness --my focus in on a nonhedonic, even antihedonic theory of happiness).

    A few details about Empirica –time for revelations. Reading external descriptions of our activities was a great source of amusement at Empirica, particularly when people made assertions with great confidence while having no notion of what our business was about, how much we had under management, and what we did with it. This went on for close to 6 years. Clearly, the author of Fooled by Randomness is not going to be stupid enough to play the “hedge fund” game –competing with spurious survivors, or having your track records examined by Sharpe ratio slow-thinkers who do not realize that the world is not Gaussian. Our tactic was to initially turn down investors with the polite “this is not for you”. We only accepted those investors who, aware of fat tails, insisted on Black Swans protection under our rigid protocols and were committed to not ask the wrong questions. The rule was that those who wanted what we had to offer came unsolicited; they knew where to find us. They trusted our rigor and saw our equipment. The Empirica “Igor” protocol which consists in “systematically buying volatility” was getting boringly prosperous, especially after the post-Sep11 dry spell in volatility, which goes against what one would have expected. Most volatility buyers went progressively out of business; many investors came to us. I enjoyed reading burst of Schadenfreude on the web every time volatility went down, with speculations about our fate –we identified some of the sources, almost always minor quants and semi-academics who felt insulted by our skepticism. After befriending Danny Kahneman in 2002, and inspired by the difference between “rent” (i.e., expense) and “loss” and such distortions in mental accounting, we transformed the outside capital management of Empirica into a “hedging” firm (except for my own portfolio and that of a large investor). People pay generously for insurance but get angry when they have a loss. An expense does not bother people as much as a loss, particularly when they see the reason for the expense. This, surprisingly, caused clients to increase the committed capital after “bleed”, because of the volatility adjustment effect. Volatility drops after these spells, increasing the incentive to hedge. After periods of low volatility, more people wanted to hedge their portfolios as the costs of insurance got lower. We also offered different portfolios to different clients, for a total of a dozen menus. We had a client with a large investment set aside for “when the VIX drops below 11”. Such business of “buying volatility” is not what I stand for as much as “tail” buying –implying that large deviations are the ones that are underestimated. But the two are weakly correlated[3]. A business that corresponds to my ideology is the “alpha” protocol in which I sold ATM options against the wings; this one did well in the drop of volatility but we could not offer it to investors because its worst case scenario was in a 10% drop in the SP500, exactly where most expected the profits to offset their portfolio losses. Selling insurance I have to say was not free work: we had to work very hard at maintaining the target properties, often worrying about the replacement of options –consider the obligation and responsibility: we HAD to produce profits in the event of a catastrophe. My greatest headaches were mistakes and out-trades.


  5. Taleb continued:

    I can reply here to questions such as: “is volatility always cheap?” It is quite silly to think that my theory of humans’ scorn of the abstract (the subject of the Black Swan), our tendency to underestimate the odds of large unspecified deviations is not compatible with our overestimating some catastrophic events, those that are in the press or vivid enough to fool our mental probabilistic map. After all, people buy lottery tickets as their cognitive system gets overwhelmed with the image of the payoff. And there is the potency of vivid causal links. If you ask traders to mentally price 1) an option that pays you “if the stock market drops by 10% any day over the next calendar year” or 2) another one that pays “if the stock market drops by 10% any day over the next calendar year owing to a terrorist attack”, the latter is likely to priced higher. Mistaking the superset for the subset is a common human error; and getting to be increasingly common under the structure of information offered to us. Buying volatility “because of event X” coming up, such as a UN vote or a scheduled crucial meeting is extremely foolish. There is no such thing as profitable scheduled volatility –we figured out that the conditional probability of a large move does not depend on implied volatility, meaning that you did better buying options when there is absolutely no reason to do so than when you saw a rationale to do so, since other traders would also be likely to identify it (there is a small adverse selection with mergers and acquisitions that made jumps more likely after an unexplained rise in implied volatility). I am more likely to profit from owning options when people complain about the “bleed” (the option premium erosion), not when they say “these times are volatile”. In addition there is a mental bias that consists in not believing that “upside” moves mean volatility. Volatility is blind to the sign of the move –not humans, implying that “upside” options can be quite interesting.

    What am I going to do during my sabbatical? The entire idea is to have no plan, no obligations: none in publishing, teaching, reading, or trading; it is exhilarating to be free and not account to anyone. You wake up without a set schedule and improvise. Even having a set book to read robs the activity of the pleasure. We underestimate the value of pure freedom. I have a small number of scheduled talks and lectures, but I never prepared for these and look forward to the chemistry with these audiences. I am writing The Black Swan without a deadline, and I am meeting people to discuss the activity for when I return to Empirica. Best, NNT


    [1] I received tons of emails from well-wishing readers asking me if there is a second visit by the old insidious “Black Swan”. The answer is (as of last November) no.

    [2] Fooled by Randomness is the first volume, The Black Swan the second, & Chance and the Logic of Happiness the third.

    [3] By saying “weakly correlated” I know I may be saying something lacking in rigor. “Volatility” is necessarily a Gaussian concept; we do not even know how to measure it –the weights are Norm L2 (meaning that observations are weighed by themselves, so large observations weigh more than smaller ones). In a power law environment, with exponent a<2 (or a Multifractal process with about any a), volatility is undefined but the fatness of tails can be known, measured by a and some degree of asymmetry. Hopefully in the victory of Mandelbrot paradigm we will not talk about such thing as volatility but tail exponent.

    In plain language this means that under a regime where much is explained by few impacting observations (“Black Swans”), the notion of measurement by “variability” is faulty. In brief there is a qualitative (not just quantitative) difference between a nonGaussian and a Gaussian world, which makes such concepts not transferable.
  6. nravo


    His writing is as prolix and pretentious as a lawyer's. I know the guy is smart, so why does he have to come off like some pseudo-intellectual? Is it an affectation? Or are the quants who love him and buy his books oblivious to the need for clarity and simplicity when discussing complex subjects in the English language. By the way, I'd still like to see his audited 10-year returns.
  7. Choad



    It's kinda hard to tell from the above posts (talk about obfuscation, sheesh...), so did Taleb lose money in his funds?

    If he mostly bought way out-of-the-money index options, then I'd say he did lose money. And Vic N mentioned that he was "glad to sell all those OTM ops to Taleb" or something like that.

    Any info you can share?


  8. ktm


    Taleb was either doing something he didn't talk about, or he was losing money. Just like VN today, he puts out a lot of fluff and "100 year chart" BS in his writings, but you know he's still selling premium.
  9. nravo


    By VN you must mean Neiderhoffer -- another quant who writes as badly as he trades. Is this guy still around?
  10. Neodude


    He runs a quazi political discussion once a month in NYC. It has to do with Libertarianism. I'm not sure if he still trades actively, but I guess you could ask him yourself.

    #10     May 9, 2005