Guest Post: Black Swan Cottage Industry And Other Tales Of 12y88y Swaps

Tyler Durden's picture


Black Swan Cottage Industry and Other Tales of 12y88y Swaps

Imagine an investing job where returns are not the issue.  The objective instead is to think about what can go wrong with a portfolio.  Even better, you aren’t really held responsible for small everyday losses, but the headline-grabbing losses that use impressive words like “multi-sigma” and make money managers scramble for excuses. 

Welcome to the Black Swan cottage industry.

It all seems a bit like the IT “stress-proofers” I saw running around in late 1999, testing and proofing and making sure of things.  And then they were gone.  The Black Swan industry is even better.  The best part of the industry is you get paid to structure protection for events that a probabilist like Emile Borel would say will never happen.  That is not to say it will never happen of course, but that the likelihood of ever having to stress-test your ideas are small.  There is no benchmark for comparison.  I suppose there is no real P&L evaluation, rather you need to minimize the carry cost to a portfolio you are attached to.  A black swan hedge is like a pimple on an ass.

I know there is something deep in our psychology to which Black Swan hedges appeal.  It seduces me too.  A part of brains are wired to fear the unknown, when they part dominates our rational thinking, we process facts in a fearful way.  There is another part that embraces complexity, uncertainty, and conflict.  This part most people need to nurture.  Why?  Because fear on an applied level equals conservatism:  when one conserves, there is no expansion, no newness.  Instead there is theory and dogma and ritual tinged with worry and despair.

A trader snorting coke off a luscious Ukrainian tummy needs the opposite.  Says the Preacher:  “There is a time to embrace, and a time to refrain from embracing.”  I think this wise rabbi means this:  learn to trust yourself, trust in your ability to rebuild and be awesome.  But don’t bet the whole megillah on how big you think your dick is.

You can make your own future by taking control of the now.  It’s is never too late.  Have hope.  We are not the Borg and resistance is never, ever futile.  
The fear creates opportunities for the Black Swan trade.  For example, a man (who loves his grandfather) and innovates brilliantly, trusts his instincts, and pushes his personal universe to the breaking point can gain big, bigger, even biggest of all.  Only to fall into a negative bubble of losses that wipes it all out.  This can leave scars, or rather, scar future investors from giving you their money.  So smart guys create black swan insurance to make reticence vanish and increase AUM.  While they are at it, they can reduce the negative carry by pimping the trades out to institutional investors. 

Black Swan trades prey on our fears, and as a result they focus on things that we really can’t get our hands around.  They are specific and systemic at the same time, using words like “counterparty risk”, and are short on effective hedging.  They neglect considering the more difficult to pin down but hugely  more realistic issues like liquidity.

Let’s say you take a view that Bank of America is a terrific investment so you go all in.  Long equity, full basis trade, the works.  And you are wrong in your view.  Sure something as big as BofA is going to impact the financial system, so your black swan hedge will pick up some bps.  But do the basis point cover the cost of the “hedge” over the time you rolled all those puts or whatever?  Black Swan hedge or not, the BofA trade screwed you over because you are at the rapier point of losses.  Perhaps a long on Goldman Sachs (who has been dialing down VaR for months because they front-run life, the universe, and everything) and no black swan hedge at all would have been a better trade.  Or you are long Kazakhstan debt when it melted down.  It’s at a “bounce” you want to exit on, but it turns out you can’t unwind the position at the quote.  You are stuck with it on the slow grind down.

It’s not that the universe was stacked against you, as opposed to everyone else.  Your view sucked.  Your view may have been terrific, but you can’t execute it like you thought.  At these times in your trading life, you sucked.  Everybody sucks sometimes in some way.     

The following is the epitome of stupid loose, people.  There are literally people buying and selling 100Y CDS (actually it looks like 88 years, like a 12y88y structure, but you know what I mean).  Correct me if I’m wrong, but this can only make sense in the Black Swan cottage industry. 

Looking at some reasonably liquid alternatives one sees no appreciable difference in how risk moves in credit and equity.  How is anchoring a hedge at long durations going to help when the counterparty risk on the entire financial system dwarfs the credit risk on a name?  Even SwapClear has non-trivial credit risk looking a century ahead.

I have such a better alternative to black swan hedges that seldom flies:  Buy cheap.  Sell Rich.  Cut your losses.  Learn from your mistakes.  Respect that part of your brain called “conservative” and dial down risk when you hate to do it.  Alternatively, tongue-kiss as everyone else stands there slack-jawed.

I just know the Black Swan Cottage industry offers imaginative, low-risk jobs.  When I’m done pissing around at it, I’ll teach other people how to not make money and manage risk.  I’ll write a book and send tweets.  Maybe I should buy a Ouija board, channel the spirit of Paul Levy and Kolomogorov, and start dictation.

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SheepDog-One's picture

I had to stop after the first few paragraphs errors and missing words gave me a headache. The guy seems pretty impressed with himself, though I cant figure out why as I have no idea what he was trying to say.

Cdad's picture


[Although I have no idea who he is], it's written like a classic criminal syndicate Wall Street banking piece.  You need a translator to figure out what the intentions are [ie you need a syndicate banker to help you through the storm].

That said, selling when the Roach Motel [SPY] goes parabolic, as it did just 90 minutes ago,seems prudent.  No translation required.  I sense the ETF/stock arb has now gone too far.  Especially when the long bond looks ready to run and the REITs look like a 2 pack a day smoker running a charity marathon.

sharkbait's picture

Well said.  It is an emperor has no clothes world.  The less sense it makes the more money you can charge because of its complexity.  And in the Wall Street, it isn;t what you know it's who you bl.. know world, nobody has the nerve to call BS.

fredquimby's picture

Damn and there I was thinking MoneyMcbags had lost his new job and was back.....

"snorting coke off a luscious Ukrainian tummy"


gaoptimize's picture

Coke? It is bad for you and what ever momentary pleasure will be more than offset by unsatisfied cravings.  Try licking the leaks from a lactating Ukrainian lady you love's luscious tummy.  They make really awesome mothers.

Stares straight ahead's picture

Your "black swan" bets these days worth only  29.999%.


Anything over 30% drop is a do-over!

masterinchancery's picture

99.9% absolute rubbish

SheepDog-One's picture

Looks like someone found this on a scribbled on napkin on the floor of a Wall St bar after mid morning martini break. WTF?

ratava's picture

Why are you calling it hedges? You can make a high payout bet on something fucking up real hard and then make sure it does. Creating artificial black swans by introducing unexpected variables which you were expecting all along.

Clowns on Acid's picture

I think the author WAS snorting coke off of a lucscious Ukrainian tummy while he was writing this post.

A Lunatic's picture

And the point is?

jm's picture

A guy asked me a question this past weekend.  Trying to answer with a little satire.


A Lunatic's picture

It seems that there are two realities within which one must learn to play the game. This year I will wrap up my diversification/insulation attempts at the personal level while continuing to engage the markets with money I can afford to lose. My goal is to be able to survive the shock of a total "crunch" personally even if it means a total loss of my current market positions. In the end I guess that's the best we can do.

jm's picture

And that is totally cool.  IMHO better than going 99% balls to the wall risk and 1% "Black Swan Hedge".

Dollar Bill Hiccup's picture

This one is pretty cool ...

Fear is always a good sell. Greed is good too, but fear I think is better.

Encroaching Darkness's picture

I had a tough time parsing this one, but I think the author was trying to say he doesn't think the folks hedging against the Crunch are likely to collect on their bets. If I misunderstood, I apologize in advance. However, there is more than one way to hedge against the Crunch (physical PMs, food, bullets, foreign real estate, etc.). Undoubtedly, some of these will be more effective than others, and paper hedges are going to be less viable, than, say, razor wire with clear lanes of fire. On the other hand, he also seems to be saying that the Crunch can be viewed as some sort of normalized-probability Gaussian-curve event, that would only occur way out on the tails of the curve, and therefore is extremely unlikely to happen, so that hedging against the Crunch is a waste of time, energy and resources. The Crunch is being actively planned, promoted and driven by voluntary acts of those who think that (a) they know from their theories it can't happen, (b) they know how to avoid or stop it, (c) they want it because they think they will come out on top somehow after it, or (d) really, really are ignorant and don't see it coming, as a direct result of their actions and/or policies. Random events can be described by Gaussian distributions and probability calculations. DELIBERATE, PLANNED AND ACTIONED events are not random, and treating them as such will not deceive anyone but those who think they are random. Reality wins, and it not only spikes the football, but rips off your head and s***s down your neck. There will be much to rebuild in the Republic after the Crunch; keep some powder dry, some assets hidden and a low profile until the Reavers have all eaten each other.

tamboo's picture

apparently the time to refrain from embracing is quite a bit shorter than the time to embrace.

Long list of Jewish Child Molestor Rabbis gets no media coverage and Jewish homosexual pedophiles are undisturbed.

SheepDog-One's picture

Maybe this article is some kind of coded Black Swan itself?

Urban Redneck's picture

12y88y Swaps

Like PT Barnum said, there is,"one born every minute."  Attach the word "hedge" and the pitch is that much easier.

Piranhanoia's picture

We are so primitive, we don't even understand the concepts we are certain of. We are so collectively ignorant that we deny scientific fact older than our own civilisation. Some of us are so mentally challenged we think the unseen dictates our actions.

Ever wonder why education is being destroyed?  It is intelligent design.

Die Weiße Rose's picture

this is what happens when you stick your head up someone's arse,

looking for a black swan....


slewie the pi-rat's picture

JM--thanks for not telling us what the question was, and who tf asked it.  after you told us there was a question, after you didn't tell us there was a question when you wrote this.

how long have you been a 5 sigma passive-aggressive asswipe?



oogs66's picture

I am left confused by much of your article, but if the point is don't go all in and then waste money buying ridiculous disaster insurance, then I agree.  And if you are so scared you need to buy lots of puts, sit in cash for awhile.  Maybe you give up some carry, but its negligible if you are right.

jm's picture

Hey, oogs.


If someone else is privy to this stuff and has a different view, I'm open to retract what I am going to say.


A 100 year credit default swap makes no sense.  Even if the reference name is a long-lived thing like a country, the counterparty issues dwarf the protection.  So you are going buy 100 year CDS protection on the counterparty too?  And that counterparty?  Etc, etc, etc.


This can only be understood by a climate of fear and too much exploitation of fear.  Fear has become a cottage industry where people put on their blinders and think that a black swan hedge has it all covered, when in fact it creates more problems.  Like if wearing seat belts makes people drive even faster and recklessly.


It has become a reinforcing mindset.  Realize that if it all goes up in flames, the survival rate is zero.  No hedge is going to stop it.  Enjoy what you have today and don’t rely on overly complicated sucker bets and purveyors of this porcupine sandwiches.


oogs66's picture

At the same time, who is selling this protection?  it does seem a bit bizarre, but the seller has many of the same risks as the buyer.  It is probably a bank on one side, hoping to widen it 10 bps and make a nice profit on the duration, and let some other sucker worry about paying for the protection for the next 99 years.  And the seller is likely someone who doesn't mark to market and doesn't post collateral (rhymes with laughaway).  In any case, 100 year CDS does seem to show how quickly the street forgets lessons that should have lasted a lifetime.

jm's picture

"Lessons that should last a lifetime."

I would say that the pendulum has just swung to the opposite extreme and will come back around. 

All the same, living in fear of the unknowable is no way to live. 

oogs66's picture

I don't think buying 100 year cds is buying black swan risk.  Buying 3 mth CDS is on JPM is buying black swan risk.  Buying 100 year is playing a game.  In fact, my guess is that all the buyers will be mark to market accounts.  All the sellers will be hold to maturity non collateral providing accounts.  The mark to market buyers will push the spread wider and book large profits as the DV01 on a 100 yr cds is reasonably high.  The sellers - insurance companies that don't use mark to market won't show a loss.  The stock of the buyer can go up as they have big earnings.  The stock of the seller can go up as they get nice premium income and somewhere in the footnotes they disclose that they disagree on certain derivative marks.


But buying 100 year cds is not playing for a black swan.  Its an expensive short.  Buying protection on super senior cds against a long position in a bank is black swan hedging.  Buying CDS on XOM to fund a long position in oil is black swan hedging as you describe.  Buying 3 mth cds on AT&T is black swan.   All of those are things where what you are buying is incredibly unlikely to have value and their are better ways to hedge the risk you have. 


I think the latter examples fit your point better.  The 100 year CDS, while sounding interesting, is probably not the best example of black swan cottage industry.  At least not in my opinion.


Again, i agree with your general premise, but 100 year cds is a bit too esoteric, and probably not an example of what you are talking about anyways.

jm's picture

I don't disagree so much with your assessment, just disgusted.  This example tells me many things. 

If you make it technical and complicated, you can sell anything.  Then it is the next sucker's problem.  For the buyer is that it is ok because it is managed money--someone else's money.  It is OK for the seller because there was a milliion made in one phone call, and that rep will be retired and living in style before he has to worry about it again.

There's other examples.  Goldman issues a callable 50 year bond last year.  Guaranteed if it ever moves in the creditor's favor, they'll call it.

Scare everyone into deflation so companies can get some cheap long-term financing.  Then scare them into inflation.  Hike margins when enough sheep are in the fold.  

People are so ping-ponged around that they see a black swan everywhere.  People make money off of this too.

I guess it has always been this way.

AldoHux_IV's picture

Translation: don't get cute with the hedges and risk management-- learn to manage emotions and not be too greedy or fearful-- contrarian when sentiment gets to a certain level is more prudent then looking at 100yr cds-- blah blah blah easier said then done.

JPG101's picture

How does a rabbi fit into all this?