Option Traders: Focus on the (dead) Turkey tomorrow

The mountains of Thanksgiving food are upon us. We are a day away from a sacred tradition in this country of surrounding ourselves with friends and family, while filling our plates (and mouths) with delicious homemade mashed potatoes, rolls right out of the oven, deviled eggs to die for, and a golden-brown turkey cooked to perfection (sometimes…sometimes its dried out or in the South – over fried).

But there’s no denying one of the main characteristics of the Turkey being served across the country tomorrow – it’s dead.  And not from lack of care or feeding – it actually died at the peak of its existence, after being fattened up just for the purpose of ‘dying’ for us to eat.  We present the turkey’s life in chart form below, but we can’t take the credit for this oh so clever chart. This idea originates from Nassim Taleb’s wonderful book The Black Swan. Taleb’s depicts “the good life” of a turkey, including round the clock care, all the food it can muster, developing a life of self-satisfaction, just so us humans can  prepare the unfortunate create for the not so pleasant surprise ending.

The Turkey Surprise

Now, we’re not going to tell you not to eat turkey and go vegan. Our angle is from the investment side, and how there is an important lesson to be derived from the untimely end of the well-fed bird. Whether the chart below looks to you like your stock portfolio since 2009 or your Bitcoin holdings – it serves as a reminder that the unthinkable can and will happen.

The turkey sees 1000 days of small gains followed by one day of large losses, and we can’t help but think of that as a lot like the performance profile of option sellers. The option sellers are technically short volatility programs which on the whole make a living by risking a large amount to make a small amount. There’s an old saying about option sellers ‘picking up pennies in front of a freight train’. They can get away with this (in theory), because they have a large winning percentage where the large losses are very rare.

But no matter the math and now matter how good your option selling manager is, or has been to date, there is no denying that they have a greater than zero chance of a large negative surprise akin to the turkey’s 1001st day at some point in the future. That if the very reason they are earning returns in the first place (in exchange for taking on that risk). Now, professional option selling managers design their programs not to lose everything on a single day like the turkey; but they are betting against the occurrence of such a day, being set up to realize frequent but small gains in exchange for the risk of infrequent but very large losses (making them perhaps a distant cousin to the turkey).

In the meantime, Happy Thanksgiving to you and yours from the Attain team!

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