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.