Rgds,

Your points are valid, but I think you might be misinterpreting my conclusion. There *could* be an event that occurs in the markets some day in the future that no person could possibly conceive of. That event could wipe you out as an option seller and the bankruptcy bell will ring. Had you purchased put options you would be touted as the hero and have your face on Trader magazine instead of John Paulson’s. Nassim Taleb purchased his put options repeatedly, and in 2008 they finally paid off. The problem is that I bet that fund will be his first and last successful foray into money management.

I guess I kind of liken it to locking oneself up in his/her house to protect against unknown mortal dangers – I could get hit by a bus, get in a car accident, fall off a building, or get eaten by a rabid dinosaur (Black Swan). Unfortunately, by locking myself up in the house I cannot make a living. I leave all of the profits to the people who seem to ignore the risk of imminent mortal danger.

When you state “Options, if well used, are a cash machine” I think you agree with my sentiment. I think that where we slightly disagree is in our use of Taleb’s Black Swan. In my opinion, it’s a neat academic idea and there is truth in many of his assertions. From a practical sense, when playing the stock market game on a repeated basis, I think it is misleading.

I think you rightly expose Taleb’s thinking on the following points:
- Stock Market returns are characterized by Fat Tails, and thus flollow an underlying power law.
- Hence, sigma is an overvalued indicator that cannot be trusted. It misses those extraordinary fat tails and the returns/loss they entail.

Though, I do not fully agree to the second part of your analysis as I think you miss Taleb’s point.
- A Black Swan Event is by definition unex
p
ected. The best we can do is hedge against those events. When Taleb says one shall be long on options, it is only a matter of the capped loss they provide (even if the payoff may be lower than selling options). You may make less money than in shorting implied volatility, but you are hedged against a potential Black Swan. You’re saying Taleb being wrong does not make sense at that particular point, as you’re target is different.

“Nassim Taleb is right in suggesting that large outlier events occur in the markets more frequently than many people account for, but I think that he is wrong in asserting that put options are mis-priced to the benefit of the option buyer.”
Being long provides a good return and hedges you against risk by capping your loss. It is almost a head you lose, tail I win situation. That’s the only reason why Taleb says they are overpriced.

But that point, I think you understand.
- Then, you bring up Boudarengo’s work and I am starting to think you missed the Black Swan’s point.The Black swan is on its whole about Statistical regress fallacy: our belief that the structure of probability can be derived from data.Historical data, as the one you bring up to illustrate your point, as one problem. It’s historical.Time series analysis is irrelevant in the estimation of Black Swans.
Does the fact that over the stock market’s lifespan the gap between realized and implied volatility was prone to option shorting mean that no event could come and erase all this gains?
If you think so, prepare for thanksgiving, you are a sitting turkey victim of confirmation bias.

Briefly, I agree with your analysis, but not with your conclusion.
Options, if well used, are a cash machine. Because mainly markets are inefficient. I however do not concur with your
criticism of Taleb’s “only go long on options” argument. Going long is the only viable way to hedge against Black Swans, because of capped losses.

Do you’ve got a source/link for this?