Doomsday Arbitrage

    In the face of nuclear war, should you buy stocks? My argument is that you absolutely should, because of  a concept I am calling Doomsday Arbitrage. I am officially coining this term, and I will explain below.

    Let's say that Russia announces that it is going to send a nuclear missile hurling towards the United States in two hours. The market is open, and the S&P drops ten percent instantly. If you put all of your money into the stock market, and this ends up not happening, you will likely make ten percent of your money back. If the nukes actually start flying, then money is the least of your problems. USD will probably become worthless in a post-nuclear-holocaust society, and regardless it will be locked up in some TD Ameritrade account. The servers linking this money to you may be destroyed, the TD Ameritrade buildings could be blown up, and/or every employee at TD Ameritrade might be dead. The global banking system has likely collapsed, and you are now in the midst of a post-apocalyptical society that will probably run on the barter system. You'll probably soon be victim to some form of incredible violence. So, you should buy stocks.

    Basically, I am saying that selling puts on the S&P500 at $100 is free money (assuming you hedge volatility). If the S&P500 ever goes below $100, you simply have bigger problems. Money is probably worthless, and you are in mortal danger. This line of thinking becomes more applicable when you apply it to a near term catastrophe in your personal life. I have always been of the opinion that given current bankruptcy laws, we should be way more risk seeking. If you can flip a coin between winning one million dollars and losing one million dollars, flip the coin. Worst case you file for bankruptcy and start back at $0. The limited downside of financial crimes and the high upside of name recognition mean that every hedge fund trader should probably insider trade, or at least take wild speculative bets. My guess is that they probably do.

    I do not think that the concept of Doomsday Arbitrage is going to make you money. However, it could  be a VERY useful idea for risk management. Is your financial advisor having money problems? Fire him. Is your fund manager near bankruptcy? Fire him. Given the asymmetric payoff for many financial professionals, you as an investor need to be very sure that you are including personal "doomsdays" into your analysis. Profiting from this sort of highly skewed asymmetric risk tolerance is difficult, unless you are in a position near ruin. Let's say you are under the poverty line and are given the chance to flip a coin. If the coin lands on heads, you get one million dollars. If the coin lands on tails, you get negative ten million dollars. This is a one time bet. If there are bankruptcy laws, flip that coin without hesitation. If you're going to be held to that debt to the rest of your life, whether you flip or not depends on how bad your life currently is. This should seem obvious, but I don't think people take full advantage of the situation. They also confuse high potential payoffs with high expected return (ex: lottery). You can translate this line of thinking outside of the financial sector, into everyday life. Given that the world is extremely uncertain, life is fleeting and fragile, and a variety of actual doomsday scenarios may be waiting around the corner, we should all be taking much greater risks.