Universa strategy

• Buy far-out-of-the-money put options on equities and far-out-of-the-money calls on commodities.
• Usually with prices 20% or more away from the then market price, and 6 months to expiry.
• Sell at the money options and buy out of the money options. Both put and calls.

The strategies Empirica used were based around buying out of money call and put options. In Empirica, roughly this meant - using the fund money to buy large amount of T-bills. Use the yield from T-bills to buy large amount of out of money call or put options. So, let see.

You buy a $1000 T-Bill with maturity date around 2 months from now at an auction for $950 (I pulled the auction price out of my rear end here. For T bills maturity is less than one year.)

This gives you $50 assured for every $1000. Meaning for a capital of $50 million, you will have $50 x 50,000 = $2.5 million to buy options in two months time. Let us say you were buying put options of S&P 500 index fund say QQQ. If QQQ were trading at $75 you buy a put option of strike price $50 at $1.25 per option. so $2.5 million gives you 2 million options or so. Now if QQQ were to crash like it did in 2008 to say $25, you will have $25 * 2 million i.e. $50 million in returns over investment of $50 million. So 100 % yield in that year. Now, it depends how bad and how frequent these crashes happen.

The barbell (a bar with weights on both ends that weight lifters use) is meant to illustrate the idea of a combination of extremes kept separate, with avoidance of the middle. In our context it is not necessarily symmetric: it is just composed of two extremes, with nothing in the centre. One can also call it, more technically, a bimodal strategy, as it has two distinct modes rather than a single, central one.

I initially used the image of the barbell to describe a dual attitude of playing it safe in some areas (robust to negative Black Swans) and taking a lot of small risks in others (open to positive Black Swans), hence achieving antifragility. That is extreme risk aversion on one side and extreme risk loving on the other, rather than just the “medium” or the beastly “moderate” risk attitude that in fact is a sucker game (because medium risks can be subjected to huge measurement errors). But the barbell also results, because of its construction, in the reduction of downside risk—the elimination of the risk of ruin.

Let us use an example from vulgar finance, where it is easiest to explain, but misunderstood the most. If you put 90 percent of your funds in boring cash (assuming you are protected from inflation) or something called a “numeraire repository of value,” and 10 percent in very risky, maximally risky, securities, you cannot possibly lose more than 10 percent, while you are exposed to massive upside. Someone with 100 percent in so-called “medium” risk securities has a risk of total ruin from the miscomputation of risks. This barbell technique remedies the problem that risks of rare events are incomputable and fragile to estimation error; here the financial barbell has a maximum known loss.

For antifragility is the combination aggressiveness plus paranoia—clip your downside, protect yourself from extreme harm, and let the upside, the positive Black Swans, take care of itself. We saw Seneca’s asymmetry: more upside than downside can come simply from the reduction of extreme downside (emotional harm) rather than improving things in the middle.

A barbell can be any dual strategy composed of extremes, without the corruption of the middle—somehow they all result in favourable asymmetries.

So take for now that a barbell strategy with respect to randomness results in achieving antifragility thanks to the mitigation of fragility, the clipping of downside risks of harm—reduced pain from adverse events, while keeping the benefits of potential gains.

To return to finance, the barbell does not need to be in the form of investment in inflation-protected cash and the rest in speculative securities. Anything that removes the risk of ruin will get us to such a barbell. The legendary investor Ray Dalio has a rule for someone making speculative bets: “Make sure that the probability of the unacceptable (i.e., the risk of ruin) is nil.” Such a rule gets one straight to the barbell.

His actual strategy is highly mathematical and has evolved over the years. But the basic position he likes to hold is to sell at-the-money options and buy out-of-the-money options; both puts and calls. The idea is that people overestimate that chance that a normal-sized move will occur. You get rich in general systematically betting that either nothing will happen or something big will happen.

The way i understood it is an iron butterfly with oversized wings.

So think of it as +2 +1 -1 -1 +1 +1. On an index like SPX this might look like:

+2 2200 put +1 2600 put -1 2800 put -1 2800 call +1 3000 call and maybe a +1 or +2 3200 call.

His ideal goal is to be delta neutral, theta positive and vega neutral. The far OTM puts provide a tail hedge against a market slide and add a vega + position.

The barbell approach is that 80-90% of the time absolutely nothing happens, but the 10-20% of the time things go whacky you have a tail hedge. By the way, only do these types of position on an index.

He likely is dynamically hedging his position to stay delta neutral, but this is something he doesn't really go into much detail.

He doesn't mention duration, but my guess is its something like 45-70+ days.

There is actually no other sound way to observe this portfolio effect, due to the nonlinear dynamics between our strategy, systematic exposures, and the compounding of the two within your portfolio. Covariances won’t show it, nor will Sharpe ratios, nor any other metric—just portfolio CAGRs. (You may recall this as the Kelly criterion.)

That seems as if you want one pocket stuffed with lottery tickets and another stuffed with insurance policies, and you expect someone to pay you to stuff your pockets. Or, in Greek, you want that magical position that is long gamma and long theta.

Note: The fund Universa, of which he is affiliated, states that it is no longer merely long volatility or gamma, but timing when to be long volatility or gamma.

Spitznagel's hedges mostly involve buying far-out-of-the-money put options on equities and far-out-of-the-money calls on commodities.

Such options give Universa the right, but not the obligation, to sell or buy stocks or commodities. Its puts and calls can typically be exercised up to six months at prices 20% or more below (or above) the market values of the underlying securities at the time the options are bought.

That means nothing short of calamity is likely to render Universa's positions in-the-money profitmakers.

For small investors, Taleb says it's possible to ward off black swans using a “barbell” strategy for hedging risk. Barbell strategies typically involve balancing your investments between two extremes. In this case Taleb recommends putting 80% of your assets into relatively stable investments, like government bonds and cash, and the remaining 20% in risky securities like stocks and commodities.

An example using ETFs might be iShares S&P Conservative Allocation Fund (AOK), which mixes Treasurys and TIPS with small caps, junk bonds and emerging market stocks.

Another option is to devote a sliver of your investment portfolio to inverse ETFs like the Proshares Ultra Short S&P 500 (SDS), which seeks to return -200% of the daily index movement. Caution: Leveraged inverse ETFs are best suited to day trading, since their prices are reset daily.

One popular doomsday hedge involves VIX index funds. The VIX is the Chicago Board of Exchange's Market Volatility Index, which rises during panics and other periods of high volatility. Among the most liquid VIX index funds is the iPath S&P 500 VIX Mid-Term Futures Exchange Traded Note (VXZ). This fund could provide a nice cushion during a crash if you can stomach losses while you wait. In 2010 the fund fell 14% and is down 23% so far this year.

Perhaps the most popular black swan hedge is gold, and the most liquid way to buy the shiny yellow metal is with an ETF like SPDR Gold Trust (GLD).

In July Universa intends to tap the financial adviser market by offering its own black swan ETF. The fund will mimic some of the strategies employed by its institutional-only hedge fund and will have an expense ratio of 1.5%.

Will Universa be able to repeat its outsize returns in another crash? Clifford Davis, head of equity derivatives at BNP Paribas , is skeptical. “A true black swan event is by definition different from all previous crises, and markets don't react in the same way.”

Spitznagel is unruffled as he sits in his office listening to classical music and losing money each day. He is ready and waiting for the next black swan to arrive.

The funds below should help you hold on to–and grow–your capital in times of crisis.