E Flattening Yield Problem & Death By Low Volatility

I like gold (GLD) and a handful of select junior gold miners to gain from volatility. But I also like going long, or buying CALL options, on the VanEck Mining Junior Fund (GDXJ) as a way to leverage gold during volatility.

Taking it a step further, it is time to use the forgotten technique of "tail-hedging."

This is simply going long ETFs, like the SP500 ETF (SPY) or other individual stocks you like. All while simultaneously buying PUT options on select ETFs or individual stocks that are long dated, 1 & 2 years, and are "out of the money" i.e. the strike price is 30-40% away from the current share price.

For instance, I could be long the SP&500 and tech stocks while also using 5-10% of my funds for long dated GDXJ call options and put options on Tesla (TSLA), or other cheap money induced equities.

Going long and also buying PUTs for the same investment even works.

This lets investors get those small weekly gains while protecting themselves from sudden spike in volatility or chaos. A favorite investor and iconoclast of mine, Mark Spitznagel, uses this strategy for his fund, Universa.

I'm sure everyone remembers the blood bath which was 'Black Monday' on August 24, 2015. The Dow fell over 1,000 points at the open ... But Universa netted over $1 billion, or 20% profits, in that day. How? Because he was 'tail-hedging'.

According to a Wall Street Journal source, Universa Investments was up close to 20% on the recent Black Monday, a trading session where the Dow Jones Industrial Average was off over 1,000 points, before recovering to finish down 588 points on the day.

You can read more here in an interview with Mark and how and why his strategy paid off so handsomely and suddenly.

With the Fed hiking and yields inverting, I think there could be a sudden shake up in the crowd's consensus, which will have these 'lowVol' investors panicking as their investments take them off a cliff.

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I look for investments that have the positive asymmetry (see-saw analogy) and that give favorable optionality. I use tail-hedging when the opportunity arises I normally use Long dated options for ...

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Moon Kil Woong 2 years ago Contributor's comment

The issue is that many run ups in the past were driven by excessive risk taking whereas this market run up is more a case of putting money in one of the few last asset classes that make decent returns more than a desire to take on risk. Because of this the move has been longer and more sustained and the risk has stayed hidden far too long.

It takes a trigger event to unwind it. For now, an obvious and predictable trigger has not presented itself. We will see if one appears on the near term horizon the next 12 months.

Lorimer Wilson 2 years ago Contributor's comment

Adem makes reference to Hyman Minsky who "taught that years of prosperity and extended periods of low volatility are what breed excessive risk-taking and speculation. Thus prolonged low volatility today sets the foundation for extreme volatility in the future. Or, otherwise said, when you feel safest and most confident things won't change, you undertake more risk because you feel secure."

You might be very interested in Minsky's 5 Stages of a Bubble - Where Are We Now? (www.munknee.com/minskys-5-stages-of-a-bubble-where-are-we-now/) which identifies the 5 stages and concludes that "How much longer and higher stocks and bonds may run in the Everything Bubble, no one can predict, but for those who stay invested in inflated assets, be aware that you are implicitly increasing your risk tolerance well beyond levels which typical risk-averse investors would be comfortable with."

What stage do you think we are in - Boom, Euphoria or Profit-Taking and why?