2023-10-06
In recent years, the rise of hedge funds exclusively focused on managing the risks associated with fat tails in financial markets has garnered considerable attention. Universa, founded by Mark Spitznagel, stands out as one of the most prominent players in this field. A book that provides valuable insights into the world of fat tails and how certain hedge funds profit from them is "Chaos Kings" by Scott Patterson.
The primary strategy employed by these specialized funds revolves around a seemingly counterintuitive approach: the continuous purchase of out-of-the-money (OTM) put options. While this strategy results in frequent losses during normal market conditions, its true potential shines during unforeseen black swan events. These events can lead to extraordinary gains, making the strategy a high-risk, high-reward endeavor. This is the daily variation of a options porftolio over 57 years that uses this strategy.
While most traditional investment funds aim to achieve consistent but modest gains each year, some hedge funds have adopted a strikingly different strategy: embracing small, consistent losses in exchange for the potential to reap massive rewards during unexpected market upheavals, such as the COVID-19 pandemic or the infamous Flash Crash. This unconventional approach, epitomized by Mark Spitznagel's Universa fund, yielded an astonishing return of 4,000%.
One standout moment in the fund's history was during the Flash Crash on May 6, 2010. At that time, the S&P 500 was trading at 1,135. A trader at Universa made a bold move by purchasing 50,000 put options worth $7.5 million from Barclays. These options would pay out a staggering $1 billion if the S&P fell below 800. It was a daring bet that showcased Universa's commitment to profiting from market downturns.
In addition to this, Universa also held $2 put options acquired in April, which skyrocketed in value to $60 when they were eventually sold. This savvy move resulted in another billion-dollar profit for Universa. Betting on a 30% decline in the S&P 500, the fund transformed a $7.5 million investment into a staggering $1 billion windfall. This remarkable success story illustrates the extraordinary potential of an exceptionally bearish bet.
PANIC EARLY
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