The Pain Trade Continues
Throwing some more capital into the dumpster fire in my portfolio
If you “have optionality,” you don't have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells
-Taleb
A large part of this game is finding areas of the market where you can get a great payoff in expressing your particular view. This is where searching out hated sectors comes into play; if the consensus is that the sector is in terminal decline, then the payoff should be substantial.
A common error is getting overly caught up in the thesis/narrative when the payoff/asymmetry/optionality simply isn’t there.
Implied volatilities impact on optionality is a easy way to illustrate this.
Hypothetically, I could write the most detailed and compelling short thesis for why Tesla is going to trade at an equivalent valuation to other automotive companies (single-digit P/E vs. Tesla currently at P/E 62). This could all sound like a no-brainer until it comes to executing the thesis.
Today, Tesla trades at $240 share, and the Dec2026 $240 strike put option last traded at $68. We would need $172 shares to break even, $104 to make 100% profit, and $36 shares to make 200% profit. If the company literally goes bankrupt, you’d be sitting on a 250% gain.
When I use the term asymmetry, I generally think 5x+, with bull calls often targeting 10x. The exception to this is if the downside risk is extremely low, e.g., buying physical uranium at $30lb, which I used as my hurdle rate for a period.
The greatest payoffs occur when there is a consensus view that there will be no tail event.
Its eyes firmly on the rear vision mirror.
Which is why this chart caught my attention.
Not so much about the probability of a recession, although I do remember Bloomberg forecasting a 100% probability of a US recession within a year in October 2022.
The probability of a high inflation tail nearing zero has real signal. The consensus belief that there will be no inflation sets the stage for the next leg of higher inflation.
I don’t know why this happens and am reminded of Brad’s response when I asked him why we see this play out over and over in the markets;
“I don’t know, but I can spin you a nice-sounding narrative if you like?”
All I’ve learned is you need to pay close attention to trading range compression and subsequent low volatility.
The below chart being a text book example I’ve what I’m talking about.
With the probability of a high inflation tail nearing zero, it makes sense oil volatility should follow suit since oil is one of largest drivers of inflation.
Oil volatility is the cheapest it has ever been on one-year, five-year, and 16-year timeframes, bar a period in 2015.
