For most of my time, I just thought of tail hedging as the "cost of entry".
A "ticket to the dance" if you like.
You can't predict what happens in the tails - so pay up to cover them & go play hard in the peak of the bell curve, where your tools and models are most valid.
If you're a good trader, you'll tend to find that your highest expected return opportunities appear after massive moves.
Disconnections happen when others risk models are flashing red and they are FORCED to trade (rather than want to).
You want dry powder for these times.
You can't predict the tails, so just get them covered and concentrate on the games you can win at.
"Getting it covered" = buying OTM options.
Other approaches such as short trend-following will *probably* pay off when you need it, but might fail.
That isn't good enough here
One of many trade-offs for the trader.
- best opportunities are in chaos
- chaos doesn't happen very often
- in benign times, easiest way to make money is carry-like stuff that incinerates your buying power just when you want it most
Tail hedging doesnt solve this, but helps
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nearly everything that is a good repeatable trading idea looks like:
"under <some circumstances> this thing is likely to be too cheap/rich because <some people> are being forced or greedy or stupid... so the thing is more likely to go up/down in the future"
your job as trader, operating in an efficient, competitive market, is to tell yourself that your idea about that is probably bullshit.
and quickly prove to yourself that it is indeed bullshit.
destroy those hopes and dreams quickly... and move onto something more productive.
you can show that something is a BAD idea way quicker than you can show yourself that it's a good idea.
and showing yourself quickly that something is a bad idea is a GOOD thing...
under the premise that all active etfs are trash, i looked at what it would look like if you could shorta bunch of them against an equivalent SPY long.
the legs are sized to equal volatility based on 120 day rolling realized vol.
highlighly scientifically, i looked at etfdb and picked 15 active / tactical ETFs based on their name and category.
here's the performance of the long SPY / short ETF pairs individually.
some did less bad than others, but all the ETFs underperformed SPY, risk-adjusted.