Buying Puts for Years?
By David Henderson
In a response to, I think, me, although he doesn’t make it clear whether he’s responding to me, Robert P. Murphy writes:
I realized from Levi’s comment that people are genuinely misunderstanding what I was trying to say in that op ed. I’m not going to try to go through it all right now, but check this out. Back in 2013, Ryan Murphy (no relation) was teasing me in the comments here, saying that I should be rich if I know the Fed is driving the stock market. I brought up that guys like Mark Spitznagel made a boatload of money from the two previous crashes, and Spitznagel is heavily guided by Austrian capital and business cycle theory. (Disclaimer: I was a consultant on that book.)
Ryan then said well let’s see how he does in the future. OK, thanks to von Pepe, I see this WSJ story that Spitznagel’s Universa Fund made a billion dollars on Monday (up 20% for the year). Does that count as “profiting from a prediction”? And no, if I understand his portfolio construction, he didn’t give half of it back later in the week, because he didn’t short the S&P, instead he bought deeply out of the money put options. (Click through to the article if you want more details.)
To be clear, I’m not saying, “The scientific validity of Austrian business cycle theory rests on the shoulders of Universa’s 3q performance relative to a passive mutual fund.” And yes, maybe Spitznagel just keeps getting lucky. My modest point is that if you think you can dismiss my perspective with a one-liner, you’re really not even trying to appreciate what I’ve been saying.
I haven’t put in all his links. If you want links, go to his post.
Before continuing, let me explain puts for those who don’t know. You buy a put option that gives you the right to sell a stock at an agreed upon price. All other things equal, the lower the price, the less you have to pay for the option. Then, if the market price falls below the agreed-upon price, you make money. This is what Universa did.
Would I have loved to have invested with Universa on, say, August 1? Of course I would. Their puts made a lot of money.
But go back to the problem I stated originally with Bob Murphy’s op/ed. I wrote:
Let’s say that you warn people that a price will fall. It keeps rising. Finally, years after your warning, the price falls. But it falls to a level well above the level it was at when you made your warning. How useful, then, was your warning?
I think not very.
How does this apply here? Well, imagine that Universa, like Bob Murphy had “been warning for years that the Federal Reserve was setting us up for another crash.” Given that Universa’s recent strategy was to buy puts that were “deeply out of the money,” isn’t it likely that they would have followed the same strategy all those years? So they would have bought a lot of puts that expired without their ever exercising them. That’s a lot of money over the years. How does it compare with the $1 billion gain? I don’t know. But I would like to know. Otherwise it’s hard to judge their strategy, even ex post.
True story: A fellow Ph.D. from UCLA, back in the late 1990s, looked at the dotcom stocks and just knew, based on fundamentals, that the stocks were overvalued. So he took some of his two daughters’ college fund and bought puts. The stocks kept rising. The puts expired. So he bought more. The stocks kept rising. The puts expired. Eventually, in early 2000, he was right. But by then, he had spent all of his daughters’ college fund and had nothing left to buy the puts that would have made him real money.