Now is the time to implement asymmetric payoff strategy?

May 28th, 2009

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A couple of years ago, when it was still a raging bull market, we wrote this guide, How to profit from a stock market crash?. In that guide, we gave a thorough treatment on the correct and safe way to profit from a possible price crash in the context of a bull market. The way to do it is to implement a trading strategy that carries an asymmetric pay-off. An asymmetric pay-off strategy is one that, as we said before in How to take advantage of an impending crash- Part 4: asymmetric payoff,

First, you structure your bet in the market such that if you lose the bet, your loss is very tiny, but if you win, your gain is very massive. Next, you bet that the market will crash within a specific period of time. If you lose that bet, place another bet for the next period of time. You do this repeatedly until the day of the Black Swan event when your profit overwhelmingly overshadows your accumulated small losses.

Obviously, the disadvantage of this strategy is that it requires fortitude to absorb small losses indefinitely while waiting for a highly rewarding final vindication in the end.

Today may be another ripe time to set up up such a strategy for aggressive traders. As this news report opined,

Apparently, Wall Street has factored all bad news into stocks. Is that a good sign, or should investors be worried if something unexpected really happens?

The market is putting itself in a position that negative surprises are no more. It may be true, but then again, Black Swans can still be lurking. We had listed two possible Black Swans in Two major Black Swans looming ahead for the global economy and one more in Is this a bear market rally or a turning point?. These Black Swans can potentially introduce another round of panic in the financial markets. For Australia, we see another possible trigger for panic- the Australian banking system (see How safe are Australian banks?).

If you are an aggressive Black Swan trader, now is the time to sharpen your tools.

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