Comments on: Two safe havens http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/ A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 http://wordpress.org/?v=4.2.5 By: Jared Woodard http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8790 Mon, 16 Nov 2009 21:02:44 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8790 “The difference is the more than amount of risk you have gotten rid of, at the market rate.”

If you’re trying to note the presence of a negative volatility risk premium paid by option buyers, you are correct (and with such nice dramatic flourishes!). Academics have noted and analyzed the phenomenon extensively, and many traders exploit it in practice.

That phenomenon does not exclude the fact that it is rational for many investors to pay the vol premium to reduce the risk in their portfolios over a relevant time frame. The vol risk premium is not prohibitively large, it keeps getting smaller, and prior to the financial crisis there were discussions in some circles about whether it would continue to persist at all. For the practical purposes of average investors with their own goals and time horizons, your concerns are misplaced.

The “second order” risks you allude to are obviously not relevant in the case of a risk-defined hedged stock position. Nobody is advocating being naked short convexity here; quite the opposite.

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By: sean matthews http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8785 Mon, 16 Nov 2009 18:26:51 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8785 Sigh (slaps forehead) – the claim is true. Yes, a stock position and a collared stock position do have strikingly different risk profiles. THEY ALSO COST DIFFERENT AMOUNTS OF MONEY. The difference is the more than amount of risk you have gotten rid of, at the market rate. You can rearrange the amount of risk you want to take on in different future states of the world, but in the end, to first order, you pay for _at least_ the risk you take on (and to second order, the chances are that you take on more risk – as a lot of people have discovered in the last couple of years – and you also have a transaction charge).

If you don’t want risk in your portfolio, buy sovereign bonds. If you want risk, buy a well diversified portfolio of the right sort of equities.

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By: Jared Woodard http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8774 Mon, 16 Nov 2009 16:23:35 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8774 “[Y]ou have not changed the amount of risk you take on for the money – you have just muddied it up.”

This claim is false. A stock position and a collared stock position have strikingly different risk/reward profiles. And the risks of each position are perfectly clear.

Your anecdotes regarding market structure prove too much: if the standard for whether someone should trade a given product is whether liquidity providers make any profit, then no one should ever invest in options, stocks, bonds, or chickens.

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By: sean matthews http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8741 Sat, 14 Nov 2009 09:27:28 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8741 Mark, maybe I didn’t put the point quite right – what I meant was that you get paid for risk, simple – if you buy intermediated products like options, then someone is taking a cut from that payment – but you have not changed the amount of risk you take on for the money – you have just muddied it up. And the more sophisticated the strategy you have for manging your risk, the more it will cost you, relative to the risk you still hold onto, and the less likely it is to be properly designed.

I understand how markets work very well. Some years ago, I spent time as an external consultant at a bank (which shall remain nameless), building pricing models for their central risk managment, and I got to see their retail options business – one of the striking things about this (which was selling, essentially, packaged collars and similar) was how casual people were – note, not particularly predatory, more with a shrug of the shoulders – about how this was a business of taking money off little old ladies. It was a memorable learning experience.

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By: VennData http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8740 Sat, 14 Nov 2009 02:52:45 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8740 What about Japanese TIPs? … matched with long-term CDS on Japan, sold six months before expiry.

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By: Barnst http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8739 Sat, 14 Nov 2009 01:55:48 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8739 I’ve venture Faber’s white paper did a fine job of managing risk, avoiding the market collapse, and is fully invested hitting highs now. I’ve been following it for a few years now.

http://www.theivyportfolio.com/

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By: Mark Wolfinger http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8737 Fri, 13 Nov 2009 22:59:58 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8737 Sean.

I never suggested that anyone buy options as a plan to earn a profit. Option buying for gain is a very difficult task.

And if that person who sells the option is a genius and does know more than you, so what? Your purpose is to protect your assets from destruction. How is the fact that someone may know more than you suggest that your trade is not ideal for your personal situation or that the price is anything but fair? That seller is not the only person selling those options at the same price.

You completely misunderstand the markets. The seller of any option or stock ALWAYS thinks there is something to gain in the trade. And the buyer feels exactly the same. With stocks, someone is right and someone is wrong. But, with options, both parties can gain from the transaction, when one of the parties is reducing risk by hedging a position.

The collar strategy requires the sale of call options and the purchase of put options. This is a worthwhile strategy for the conservative investor.

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By: Dan Hess http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8736 Fri, 13 Nov 2009 22:48:23 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8736 Buffett has said the safest investment for a young person is in skills and education. If you are old, educate the youngun’s in your life. Ain’t no government can take away your skillz.

For many Americans up to the eyeballs in high interest debt, a fairly good bet is to pay that down.

Infrastructure may be a decent bet in the coming years. It is tangible and is therefore an inflation hedge. Plus, it is likely that state and local governments under financial duress in the coming years will want to unload assets.

Jim Rogers sees farmland as the best play right now. Again, it’s tangible, hence an inflation hedge. It will continue to be as important as it has been since the dawn of man. Need to find a way to rent that and get decent yield in the interim, if you aren’t a farmer yourself. If you are a farmer, he tells you Maseratis are in your destiny.

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By: sean matthews http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8730 Fri, 13 Nov 2009 21:33:24 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8730 To a first approximation, still, even after what has happened in the last couple of years, you pays your money and you makes your choice, and your choice is more or less a function of risk tolerance. If you want to avoid risk, then choose simple unintermediated positions which involve little risk (extreme case sovereign bonds); if you are comfortable with more risk, then choose simple, unintermediated positions which take on more risk (extreme case emerging market ETFs). Avoid ideosyncratic risk (i.e. do not invest in single equities). And DONT BUY options, which are neither simple nor unintermediated and are sold to you by people who are better informed, and have more time and resources to think about the situation than you do, and would not be selling you the option if they did not think there was something in it for them – if it is only the servicing charge of maintaining the dynamic hedge.

This will not protect you from catastrophe, but it is more likely to do so than any other strategy.

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By: Big O http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/comment-page-1/#comment-8728 Fri, 13 Nov 2009 19:04:59 +0000 http://blogs.reuters.com/felix-salmon/2009/11/13/two-safe-havens/#comment-8728 If we lived a in black and white world, perhaps those would be the only 2 choices…

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