The Whale
It’s been some time since my last post however the world of risk and finance has continued to burn.
Bruno Iksil, aka The London Whale, aka Voldemort was a trader in JP Morgan’s Chief Investment Office who’s disastrous European credit bets wiped out $2 billion. What’s interesting is that these bets were supposedly a “hedge” but weren’t placed from a prop desk but from within the relative safety of the CIO. With the passing of Dodd-Frank and the subsequent banishment of all proprietary trading on Wall St it seems odd that these massive bets are still finding their way through the loophole roller coaster. I think it goes to show that smart bankers will always find a way to disguise their trades.
The media fury over The London Whale is still ongoing but with the European Union melting down the Whale shenanigans are being put into perspective. No government bailout will be needed for JPM and most people would seem are just shaking their heads saying bankers will be bankers. Of course there is a 100% chance the government will be looking into this trade even though it doesn’t appear to be illegal, just stupid. Iksil has resigned as has his boss. CEO Jaime Dimon has been subpoenaed as well to discuss knowledge of the trade. I can’t imagine it’s very rosy over at JPM considering they made a bonehead trade, lost a ton of money, disclosed it to the public and now the government wants to kick them while they’re down. It’s not shocking considering the bailout money taken by Wall St and JPM.
The most interesting thing I read from the JPM debacle was this article from the FT talking about the impact of this trade on risk models most namely VaR or Value at Risk. VaR is a quantitative measure designed to highlight the maximum amount of losses of a portfolio given a certain probability. For example a 1 Day VaR of $10 million at 95% may mean that there is a 95% chance that the most you could lose is $10 million over a 1 day period with no trading. The flip side is that there is a 5% chance that the LEAST amount of money you could lose is $10 million. There is plenty of material to read on VaR.
The article in the FT further states that VaR is no longer a valid method of measuring risk and lack of robustness contributes to the massive losses we’ve been seeing. To be frank, the article is a bit outdated as the shortcomings of VaR have been widely discussed for years.
It’s just amazing that VaR is still widely used. There is a distinct need to understand risks in our world today and for some the concept of tail risks and the fact that the outliers cannot be truly measured is terrifying. I’ve faced situations like this in the corporate world where a set of risks is laid out and addressed and ultimately everyone feels better and can sleep at night but when push comes to shove all we’ve done is over inflated our own knowledge of the issues. The risks always end up being higher than estimated.
The answer for measuring risk is simple; THERE IS NO ANSWER.
It’s how you address risk that is important and not necessarily understanding every risk.
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Selling Teenies
I wanted to pass along this fun article from ESPN magazine.
Bob Hamman runs SCA Promotions which essentially provides insurance to promotional contests throughout the sporting world. The contests range from basketball shots at halftime of NBA games to hole in one contests at golf tournaments. Chances are you’ve either seen these contests or participated. They’re all good fun but what happens when someone actually wins?
SCA was founded in 1986 and is now the world’s biggest insurer. When a contestant wins the promoter pays out the prize and if they’re insured with SCA collects on the amount of the prize. In exchange they pay a premium for this protection just like insurance.
Hamman’s background is as an actuary and like Warren Buffet he is one of the top bridge players in the world so he’s well versed in statistics. The article does a good job explaining the mechanics of how they assign probabilities.
In the trading world we call this selling teenies. Teenies refer to contracts that are very far out of the money and have a low probability of finishing in the money. In many cases selling these is similar to selling insurance but is also as close to picking up nickels on a train track as you can get. Like Hamman’s these best are highly asymmetrical in a negative nature. While they might provide steady income generally the one or two that do end up losing you money will with a high probability negate any previous returns and quite possibility bankrupt you. People have gotten rich from selling these things but they don’t normally stay that way for long.
The big difference with Hamman is that his downside is limited by the notational amount of the payout so he knows his risk. Depending on the odds he will charge between 3-15% of the prize value. In the 25 plus years of doing this he has collected fees on over $10 billion in prizes and paid out only $170 million in winnings. So if he collects on average 9% for each bet he’s got $900 million in fee revenue and $730 in profit with an 81% margin. Not bad business if you can get it.
It’s an interesting business and one that I know many traders try to emulate however it’s more than likely they fail to understand their risks unlike Hamman and SCA.
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Steve Jobs
I recently read Walter Isaacson’s excellent biography on Steve Jobs and the book struck a chord with me on multiple levels especially in how it fits the themes of this blog.
First of all Jobs was a genius but he was batshit insane. He was very harsh in dealing with people and employees and from an early age determined that normal rules and laws did not apply to him (he never put tags on any of his vehicles and routinely parked in handicap parking.) His genius was in his appreciation for design and the ability to turn ideas into top shelf product among other things. Jobs openly admitted that he did not posses the mental capabilities or engineering skills that his first partner Steve Wozniak so effortlessly displayed but his vision is what turned Apple from a computer hobby venture into the most valuable company in the world.
Where Jobs fits into the scope of this blog is first of all the true outlier nature of his life and career. In a little over 30 years Jobs and his team transformed the world as we know it. The way he did this was by focusing on quality products and one goal: make it simple. If you’ve ever owned an Apple product (and really who hasn’t at least used an ipod) then you can appreciate the sleek, intuitive design and interface it possesses. Like a light bulb going off, the mantra of keeping it simple is one that should be repeated and applied throughout life. I don’t feel it speaks to our education (or perceived lack thereof) to make things simple I believe it is the concept of elegance in the form of simplicity as opposed to a product or concept over engineered and clunky. If there is any other adjective to describe Apple products other than simple I’m positive elegant is fitting.
Despite Jobs’ vision and genius he suffered from a hubris that ultimately cut short his life. Jobs was persistence in his passion for zen, veganism, hippie culture and drug use commenting that it was ”one of the two or three most important things [he had] done in [his] life.” As a Reed College dropout Jobs wore Buddhist robes and traveled to India to seek out enlightened teachers as well as worked at an apple farm (the inspiration for the company name) run by a hippie friend of his. During this phase of Jobs’ life he became extremely strict on his diet subsisting on carrot juice and fruit for months on end. Even as the years wore on his diets changed but remained free of meat and natural sources of protein. What followed was a debilitating form of cancer and ultimately a liver transplant. Even more shocking was his refusal to treat the cancer with modern medicine despite pleas by family and friends. In fact when surgery was absolutely necessary Jobs delayed it for months hoping for “natural” remedies through a stricter diet. Where Jobs obviously went wrong is two fold: his severe lack of protein intake for years did extensive damage on his pancreas and liver not too mention his overall health and as before he believed the rules did not apply to him even in the physical sense.
Let’s be honest, I’m not doctor nor am I an expert in pancreatic cancer but it was pretty clear to me that a life spent eating like Jobs did had done irreparable harm to an amazing man. What seemed strange is that no one ever made the connection. Issacson not once mentioned a history of cancer in Jobs’ family (he was given up for adoption but eventually reunited with his birth mother and paternal sister) nor did he leave any clue to why Jobs developed such illnesses but it seemed pretty clear to me. I would be interested to have someone with a bit more expertise in the area breakdown his illness and the possible causes.
The book is a surprisingly quick read for 600+ pages and one that I highly recommend. Reading about these amazing products and how they were created often with one or two whimsical ideas or decisions is quite frankly fascinating and valuable knowledge. What Jobs lacked in tact he more than made up for in persistence and results. Like other great minds he was extraordinary and eccentric (to put it lightly) but its obvious that the world is better off having known him.
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Change
Since this blog is about extreme events in life and mixes in some health then it seems all the more appropriate to speak about one of life’s biggest events; the birth of a child. It just so happens that I had the chance to experience this not long ago with our first baby. To say my life has changed would be an understatement.
Now I could make this post about how amazing the birth was and what a rockstar my wife was and how perfect our child is but I won’t (although it was, she was and she is.) Instead lets look at a couple of things pertaining to kids that fit in a bit more with the theme of this blog namely health and something a bit more peculiar. I promise this blog will not turn into As My Baby Cries: A Documentary
Part I
In keeping with our devotion to Art DeVaney and his new age cavemen diet I stumbled about this blog post about raising kids in a similar manner.
I encourage you to read the whole post but I’ll summarize.
- Some guy in Hawaii who is devoted to Paleo movement decides to implement a similar concept with his offspring.
- He starts with changing his wife’s diet during pregnancy, she has no problem being told what to do.
- Baby comes out wide eyed with a six pack and full head of hair, styled perfectly.
- Baby supports head at 10 days and sleeps all through the night from birth, also does a load of laundry during the day
- Baby prefers diet of rib-eyes and asparagus and disdains any cereals or sugar
- Baby is on the far tail of distribution for height and at the perfect weight
- Author chalks it up to superior child raising or superior genes
Ok so I’m embellishing on most of these but the basic information is what he claims is factual. I’ve read a lot of baby blogs and I’m a firm believer that everyone has their own way to raise a child and there is really no right or wrong way (assuming you’re meeting all the basic requirements of food, clothing, shelter, etc.) However, I was pretty intrigued with his methods knowing that I had taken a similar approach to my own diet years ago with positive results and too be honest what parent doesn’t want to say that their baby sleeps all night, is not colicky and is the upper percentile of height/weight? Come to think of it isn’t that the whole purpose of this blog? To live and operate on the far right tail of the distribution and to strive to be extremely above “average”?
What if you could start over and take away all the years of hard living on endless diets and exercise plans and tell yourself, “Hey, self, if you change this and tweak that when you’re younger you’re gonna be waaaaay better off in the long run and you’ll feel great in the interim.” What better way to do that than with your own child (ignore any similarities to a high school science fair project.)
Like the basic concepts of Art DeVaney and paleo type living I have to assume that human babies have been born and raised for thousands of years and only in the most recent century can we say they were exposed to the types of diabetic causing foods that millions of people (i.e. Americans) are subject too. I’m definitely not saying my baby will never taste cake or eat cookies or what not but perhaps its worth the effort and ridicule to try something different. Giving babies huge chunks of meats to gnaw on? Now that’s different. Effective/safe? Not sure but I’m sure something similar has been in practice for thousands of years and the human race is still going strong.
Like with raising any child it is a two person committee and someone usually holds a larger percentage of the voting majority although I won’t say which parent. My point is that while the author of the above post really took over the entire process he met a lot of resistance namely from his wife, the doctor and the grandparents. I’m not sure I could follow a similar plan but if you even get some of right you just might be on the upper part of the curve. The fact that there is so much backlash gives me reason to try something like this. After all, most of the advice and information you get on raising a child is designed and mined from what is determined to be safe, healthy and average. No reason you can’t be aware of the former while working on being above the latter.
cont…
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A Long Layoff but Some Things Never Change
It’s been entirely too long since I posted something but hiatuses tend to happen when you’re moving your family and starting new jobs.
However, this one was too easy to pass up.
A former Goldman Sachs trader who opened a Japanese themed hedge fund in 2006 was essentially wiped out in a mere two days following the devastating Japanese earthquake.
There is no doubt that he is not the only person to have suffered during this volatile period but the story is all too familiar.
Some highlights of the article:
- Had returned 36% in 2009 and 22% in 2010 with only 2 down months
- Part of its strategy consisted of long Japanese dividend swaps whereby it profited from stable markets
- From the sounds of it an unhedged short put spread on the NIKKEI (guessing the 8000/10000) which also capitalized from a stable to higher market.
- Lost nearly 75% of $150mm AUM in about 2 days when liquidity dried up and he was forced to liquidate.
The fund, Gaia, was clearly short volatility which can have its benefits but also highlights the concave nature in the returns using such a strategy. Also clear is the black swan nature of this earthquake in that few if any could have possibly predicted the event. The main thing that sticks out to me is that the gentleman, Kenichiro Nishi was happy to show consistent 25% returns per year but at the risk of a complete blowout. Either Mr. Kenichiro underestimated these risk or he simply ignored them.
How can you estimate the risks of a catastrophic earthquake and subsequent nuclear meltdown? Well, you can’t but once in a lifetime market movements sure seem to happen more often than that so trade accordingly. There is an event out there right now that has the potential to do just as much damage to the markets. I don’t know about it and neither does anyone else but it will come.
Often to successfully trade you have to make assumptions about outcomes and assign probabilities of each outcome to get a better picture of your expected payout. Assumptions are never easy but rest assured that whatever worse case scenario you can dream up the actual event and the manner with which it evolves will usually be far worse.
You know what they say when you assume…you make an ASS out of U and ME
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