I don’t know if the puts he’s written can be sold to a third party or if they’re indexed to inflation.

I mean the ‘troubles’ he notes are well known to people who value options and for quite some time (like almost 20 years…).

I guess blaming “model risk” is complex enough to snow people with an explanation, other than that ‘we doubled-down that there wouldn’t be a downside this big and we were wrong’.

His logic is that of an insurer, using actuarial type probabilities rather than market indications. He is also correct in his criticism of Black Scholes for long tenor options. In fact, he mentions just a few of the problems among many.

Still, these options may be more valuable for some than Black Scholes value. For example, a quant should start valuing them not as plain vanilla options, rather path dependent, knock-in options. In the end, the correct value depends on the assumptions you make, just like everything.

Buffett knows his stuff. From his perspective, these puts are little different from other insurance policies he writes. He may not win them all, but the odds are tilted in his favor.

I wonder if Taleb thinks those puts are ‘too expensive’.

The hedging fails of course just when you need it most – when there are big jumps in the market. Older readers may recall the 1987 crash which was in large part caused by failed attempts to hedge against market declines. In those days it was called portfolio insurance.

Of course one might suspect that WB is making excuses for his losses selling options. One thing he doesn’t seem to have acknowledged is that the “investment returns” he is expecting to make from the premiums are going to be highly correlated with what he insuring. If the market tanks long term – as other markets have eg Japan – and he has to pay up on the puts, his investment returns are also likely to be lousy. Correlated risk is bad. Also note that WB is not a young man so the returns will have to be achieved by his successor who may not be as good an investor.

Just too bad none of the brokers, counter-parties or clearling-firms buy such an argument (even if any were possibly stupid enough to do so, their own CDS would blow-up, fatally-damaging their own financing arrangements: thus winning themselves the Darwin Award)…..

Well, if he *truly* believes that Black-Scholes “overstates” long-dated options values, then he should just go all-in: Sell an infinite number of puts on an infinite number of indices what’s the worst that could *possibly* happen…?

After all, AIG is getting yet another free $30bil from the US Gov’t for it’s negative-convexity-bet gone wild, so why not do the same and pick pick-up some free cash from a negative-gamma dice-throw….?

In all seroiusness, If someone can come along with a “better” formula that prints money and doesn’t blow you up, then, hey, I’ll take it; I just find it awfully convenient that he’s cryyyying a river now that his “free money” bet (short the options, collect the premia for 20 years, and like, there’s *no* penalty to pay until the very end) is beginning to do a Nick Leeson on him, and his CDS premia are exploding, counter-parties are easing-back and it’s all hitting the Bloomberg screen at an inopportune time…

With regard to BS, “absurd” values are generated in times of extreme risk as uncertainty grows. How else are traders supposed to manage risk? It’s not like there’s a crystal ball out there that says “this low and no lower.” Unless of course you believe, like Bill Gross, that the government will set a floor to values…