I've probably mentioned this theory before, but: stock markets are a bad indicator for predicting nuclear war. If a nuclear exchange happens, stocks go to zero, so the optimal move for a local is to buy any dip caused by nuclear risk. Dead and broke isn't any worse than dead.
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Replying to @ByrneHobart
Seems like the optimal move for a non-local is buying grossly mispriced deep out of money puts, if that is one’s view on matter.
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Replying to @patio11
The trick with those bets is similar to one of the risks that real estate shorts had in 08: if you're right, your counterparty may not be around to pay. (If AIG hadn't been bailed out, or had been bailed out with a haircut for CDS counterparties, things would be different today)
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Replying to @ByrneHobart
This feels like an unsatisfactory argument to me, since that answer should make the position cheaper: if you think that is a material risk, short the counterparty. Big Short had a bunch of people who were approximately right but nobody who was approximately right *about AIG.*
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Replying to @patio11
Like, if one knows that Godzilla strikes Tokyo tomorrow, it seems impossible to me that that fact correlates with no instrument outside of Tokyo.
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Replying to @patio11
That's true: if you bought a bunch of diversified OTM puts, the ones that paid off would more than compensate for the counterparties who went under.
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Replying to @ByrneHobart
Random question for you: if a time traveler came to you in 2005 with a copy of The Big Short and convinced you of authenticity, what was the optimally capital efficient position there? (Coarse enough granularity to know names and dates but not like individual put expiry prices.)
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Replying to @patio11
It was, for somewhat complicated reasons: long CDS on AAA-rated tranches of subprime-backed CDOs, but *also long the equity tranches*. Basically the intra-CDO asset correlation was higher than people thought, making 0 defaults and tons of defaults *both* more likely.
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Replying to @ByrneHobart @patio11
While far-OTM options might have had a higher payoff, I'm not sure there would have been as much liquidity (and if you'd bought in size it might have spooked people), whereas there was enormous demand to take the other sides of both of those trades.
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Replying to @ByrneHobart @patio11
Plus, since that trade has long and short exposure to the same pool of assets, you'd be able to lever it up a lot.
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Thanks, this is one of most informative things I’ve ever read on Twitter.
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