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June 14, 2020 | Tail-Risk Hubris Goes All-In

Rick Ackerman

Rick Ackerman is the editor of Rick’s Picks, an online service geared to traders of stocks, options, index futures and commodities. His detailed trading strategies have appeared since the early 1990s in Black Box Forecasts, a newsletter he founded that originally was geared to professional option traders. Barron’s once labeled him an “intrepid trader” in a headline that alluded to his key role in solving a notorious pill-tampering case. He received a $200,000 reward when a conviction resulted, and the story was retold on TV’s FBI: The Untold Story. His professional background includes 12 years as a market maker in the pits of the Pacific Coast Exchange, three as an investigator with renowned San Francisco private eye Hal Lipset, seven as a reporter and newspaper editor, three as a columnist for the Sunday San Francisco Examiner, and two decades as a contributor to publications ranging from Barron’s to The Antiquarian Bookman to Fleet Street Letter and Utne Reader.

Investment manias are nothing new on Wall Street, but this time the heavy betting is on the mania itself.  Speculating on volatility is the latest fad, and it is metastasizing so quickly that in just two short months wagers that the stock market will grow even crazier have become the actual cause of its craziness.  The bets mainly involve  derivatives, including options and ETFs that are tied to trillions of dollars worth of stock. Big guys, little guys and everyone in-between are supposedly immersed in this tail-risk crapshoot, and it is causing markets to spasm wildly not for bullish or bearish reasons, but rather, as implied above, because of the volatility bets themselves.

Tail-risk mania’s fuse was lit in in January, when some canny institutional traders loaded up on then-cheap insurance against a market crash. This speculation proved to be timely, but it was more than just luck. They had access to good information that wasn’t available to most investors at the time. While some caught a faint whiff of Wuhan’s troubles back then, the stories were buried on inside pages, and few would have suspected that the threat of a pandemic would soon engulf the planet. The money managers, along with some muckety-mucks on Capitol Hill, were hearing the stories too, but with an urgent, well-informed emphasis on scary details that put the China crisis in play as a cheap speculation.

A Covid-19 Epiphany

The son of a friend saw it all coming in January because he got very sick himself after Chinese classmates returned to MIT following Christmas break. He nearly died, and the experience led him to warn his parents and grandfather to sell all of the stock in their portfolios. The hedge fund guys were on top of situations like this too, and its dire implications hastened their full-tilt shift into risk assets. Some of them have reported gains exceeding 200% so far this year.

Lately they’ve been talking their book, baiting an eager news media that is often a crucial step behind the manias they love to write about. The Wall Street Journal, for one, ran a front-page article over the weekend under the headline Investors Bet on Volatility, Making Markets Even Wilder. It extensively quoted one Paul Britton, founder of a firm called Capstone Investment Advisors that is among the biggest players in tail risk’s Big Casino.  On the runover page, Britton is pictured in profile, absorbed in thought as he gazes across a prairie panorama earnestly searching for the Next Big Thing. A blow-up would make an inspiring poster on the bedroom wall of a millennial who recently discovered, not Rita Hayworth or Farrah Fawcett-Majors, but day-trading. Does he even suspect that Britton and his ilk have already moved to the other side of the bet, selling risk premium fattened to enormity by the pandemic and its grave list of unknowables?  Nothing short of Armageddon could push pandemic put options in-the-money, and yet they are still an easy sale, the ultimate moral hazard.

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June 14th, 2020

Posted In: Rick's Picks

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