I am reading about how Spitznagel does hedging from Forbes - Protect your Tail.

It's unclear to me how he is getting the returns he is claiming,

Spitznagel's hedges mostly involve buying far-out-of-the-money put options on equities and far-out-of-the-money calls on commodities. Such options give Universa the right, but not the obligation, to sell or buy stocks or commodities. Its puts and calls can typically be exercised up to six months at prices 20% or more below (or above) the market values of the underlying securities at the time the options are bought. That means nothing short of calamity is likely to render Universa's positions in-the-money profitmakers.

When things do go very wrong for the underlying markets, however, they go very right for Universa. As the Standard & Poor's 500 dropped 38.5% by the end of 2008, the fund increased its investors' money tenfold. Spitznagel says that investors generally allocate about 1% of an investment portfolio to fund such a "black swan protection protocol."

So he is long 20% OTM Puts/Calls with 6 month expiry with 1% of the investors funds. Using option-price.com to estimate the prices before and after the events,

At time of purchase (underlying=$100, volatility=20, interest rate=5, div yield=1),

  • 20% OTM Put (strike $80) at 180 days = $0.21
  • 20% OTM Call (strike $120) at 180 days = $0.925

After market drop (underlying=$80, volatility=25, interest rate=5, div yield=1),

  • 20% OTM Put (strike $80) at 90 days = $3.551 (16.9x return)
  • 20% OTM Call (strike $120) at 90 days = $0.002 (0.002x return)

Average return = 8.45x

After market rise (underlying=$120, volatility=20, interest rate=5, div yield=1),

  • 20% OTM Put (strike $80) at 90 days = $0.0 (0x return)
  • 20% OTM Call (strike $120) at 90 days = $5.328 (5.76x return

Average return = 2.88x

So it's clearly realistic for the hedge to multiply by 10x, but for the total portfolio to multiply 10x at a 1% allocation, we would need a 1000x hedge return, which doesn't seem realistic.

  • I think you're right, the returns claimed are probably for the option position, not the whole fund. Might be an error on the writer's part.
    – Earth
    Apr 16, 2019 at 0:29
  • I don't find the words misleading. "Increased its investors' money" normally means the money invested in the fund in question, not all the money the investors have. The "investment portfolio" mentioned is not the Spitznagel fund's portfolio, but that of someone who buys this fund. All (or almost all) the money given to the fund is placed in the options. The fund goes bust over and over but occasionally pays off big (10x). Due to this extreme volatility, the investors (the people who buy this fund) allocate only 1% of their portfolios to it. When the fund returns 10x, they gain about 9%.
    – nanoman
    Apr 16, 2019 at 2:10
  • A quick Google search finds mention that Spitznagel's Universa Investments LP made returns of above 100% for its clients in 2008. The 1% allocated to tail risk paid off handsomely. Apr 16, 2019 at 4:43
  • FWIW, if anything, a 2017 article indicates that according to data by CBOE Eurekahedge, those who invested in tail-risk funds when their performance peaked in September 2011 would have by now lost 55% of their money. Such funds have fallen out of favor because of this. Apr 16, 2019 at 4:45

1 Answer 1


Some random thoughts...

Is that 1% allocation per year or 1/2% every 6 months?

Hedging for tail risk is a losing proposition in most years. Kind of a lottery ticket that hits infrequently.

Your average return calculation is incorrect. If you buy the 6 month 80p/120c strangle for $1.14 and it's worth $3.55 three months later, that's a return of 2.11x. Averaging the returns from each side is incorrect.

Your P/C calculations appear reasonable but in 2008, the VIX got up into the high 70's. That's likely to be why his payoff was so great that year. If you use 75 as the IV, the payoff should be 20-25x or so. At $80, even with that large of an IV, the $120 calls would have a massive profit. And given that the market lost 50+ pct in 2008 until the March 9th bottom, there would have been a lot of intrinsic value gained as well on individual stocks that cratered (for example, the financial SPDRs were down 75% during that period).

My 2 cents is that one would be better off focusing on the downside tail risk. Markets don't melt up.

  • "At $80, even with that large of an IV, the $120 calls would have a massive profit" -- this is confusing -- sounds like you think the calls are shorts, but they're longs. "Markets don't melt up" -- it says the calls are on commodities, which sometimes do (e.g., oil shocks).
    – nanoman
    Apr 16, 2019 at 2:00
  • @nanoman I think he was saying that even with such a high IV, the long call increases in value. with the IV set to 75 as he suggests, even with a 30% drop, the long 20% OTM call gets to $1.172. While not a huge gain relative to the put at $49.874, it is a gain from the original price.
    – user32205
    Apr 16, 2019 at 3:17
  • @aidan.plenert.macdonald So the call theoretically goes up 27%, not exactly a "massive profit" in this context. But it's not "even with [despite] such a high IV", it's "due to such a high IV". In addition, I believe that realistically a large IV skew would develop, and the IV at $120 strike would be much less than 75. It's implausible that, after a crash, the market would consider the stock more likely to finish over $120 (or any given strike) than before. So I expect the direct effect of a crash on calls should always outweigh the increase in IV. Perhaps this has been studied.
    – nanoman
    Apr 16, 2019 at 3:39
  • You can nitpick the words used in any way that you want. With a $100 underlying that drops 20% to $80 and if the call that is $40 OTM increases significantly in value, that's massive to me. In any reasonably normal situation, the call would be worthless. But more to to issue at hand, the OP asked for a realistic reason supporting the numbers and I stand by increased IV and possible intrinsic value as the evidence. Additionally, the VIX IV was 75+. It's not a rare thing to see stock IVs well over 100, assuming Spitz is going that route rather than ETFs (SPY, IWM, etc.) Apr 16, 2019 at 4:40
  • BTW, I cited a 20% drop in the underlying in my "massive' comment. With an IV of 75, that yields a call value of $2.68 which is a triple, not up 27%. And yes, calls on commodities which sometimes do shoot up due to oil shocks, except that we're talking about Spitznagel's return in 2008 when unfortunately, crude oil dropped about 60%. That's the wrong kind of shock for commodity calls. Apr 16, 2019 at 4:54

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