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Both Kyle Bass (from about 8:00 - 9:40) and Mark Spitznagel discuss an approach to finance where an investor takes a small percentage of their wealth and bets on an unlikely outcome, expecting to lose everything, but if right, makes 50-70x (70 was Kyle's figure) their bet. Setting aside the obvious bias in video one, I'm curious how this works in a portfolio.

Explanation:

Let's use an example. I work in the financial industry, which has been strong recently. I allocate my $500K mostly in stocks, bonds, cash and metals. However, I take a one percent slice - $5K - expecting to lose all of it every year that will "bet" against my industry as a whole. If my industry falls that year (many industries have year or two year declines every decade), I get 70x the $5K that I bet ($350,000); if it rises that year, I lose my $5K, but the majority of my money is a bullish investment on stocks anyway. Consider that those in the energy industry right now could have used this, as the decline in energy has been harsh and we're now past one year of a full decline, since it began in July of 2014.

Question:

Both Bass and Spitznagel indicate that they do this through put options; like buying a put option on a financial basket ETF, betting on a fall.

Since some of you excel are writing out examples using numbers, can anyone provide an example of how to do this using any industry where someone "hedges" their risk using options?

Thanks!

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This is a snapshot of the Jan '17 puts for XBI, the biotech index.

enter image description here

The current price is $65.73. You can see that even the puts far out of the money are costly. The $40 put, if you get a fill at $3, means a 10X return if the index drops to $10. A 70X return for a mild, cyclic, drop isn't likely to happen.

Sharing youtube links is an awful way to ask a question. The first was far too long to waste my time. The second was a reasonable 5 minutes, but with no example, only vague references to using puts to protect you in bad years.

Proper asset allocation is more appropriate for the typical investor than any intricate option-based hedging strategy. I've successfully used option strategies on the up side, multiplying the returns on rising stocks, but have never been comfortable creating a series of puts to hit the jackpot in an awful year.

  • Thanks @Joe. The YouTube videos are for reference only and I updated the question to include the time frame on the first video (only 2 minute portion); the question mentions what both Bass and Spitznagel are advocating. I wanted to see the numeric form of what they're advocating. This answers my question. – user541852587 Dec 13 '15 at 16:21
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That's not unemployment insurance. Because it's perfectly possible, and even likely, that your industry will do badly but you'll keep your job, or that your industry will do well but you'll lose your job anyway. Any bet you make to insure yourself against unemployment has to be individually about you -- there are no suitable proxies.

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Options do act, somewhat, like insurance.... However.... An insurance policy will not have such short term expiration time frames. A 20 year term life insurance policy can be thought of as insurance with an expiration. But the expiration on options is in weeks, not decades.

So (IMO) options make terrible insurance policies because of the very short term expirations they have.

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