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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DISCLAIMER

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.

The entries on this blog are intended to further subscribers understanding, education, and – at times- enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex, and is not intended as investment advice, or an offer or solicitation for the purchase or sale of any financial instrument. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts. Opinions expressed are that of the author.

*The mention of specific asset class performance (i.e. +3.2%, -4.6%) is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.), and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship and self reporting biases, and instant history.

The mention of general asset class performance (i.e. managed futures did well, stocks were down, bonds were up) is based on Attain’s direct experience in those asset classes, estimates of performance of dozens of CTAs followed by Attain, and averaging of various indices designed to track said asset classes.

It should be noted that past market performance is not indicative of future market movement.No market data or other information is warranted by Attain Capital Management as to completeness or accuracy, express or implied, and is subject to change without notice.

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Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.