Byrne Hobart explains that he likes to apply financial language to human behaviour.
He sees the financial world as a testing ground to observe how we will react given different monetary incentives.
In your life is (almost) a call option, he attempts to draw different similarities between the payoff we observe in the options market and the decisions we make in life.
I think the most fascinating part is how similar options speculators/investors are compared to how some of us make decisions.
I think options might not be so easy to understand compared to a lot of other investments. I would readily admit that I haven’t pieced together how options work and executing them well enough.
Thus, you might struggle to understand some parts of what Byrne shared.
After reading his piece, I reflected upon how different I would do things and how some of the people we came across do things.
When your life is not in a good spot, there is a high incentive to gamble on risky, destructive bets.
Getting a lot of money usually means you need to gamble, or get into a lucrative company/profession or be successful in a business.
You would have friends who were very successful and had made it big in their career or business despite them not being very educated.
Sometimes, my friend would tell me, Kyith you considered so much stuff but maybe if you have just wack, the business or investing outcome would be very different. Don’t overthink things.
If we are an ITE student, becoming a consultant, or an assistant director in a government organization, or getting into the C-suite is a long shot.
There are some decisions we made in life that is very similar to whether we want to buy or sell a very out-of-money call option.
The thing about an out of market call option is the volatility is very high. If your decision works out, you can reap the exponential benefits throughout your life relative to the cost you put in.
But if your decision does not work out, you lose everything.
If you sense a glimmer of opportunity, you would risk everything on it. Wouldn’t that be too dangerous?
What is the alternative? You struggle a little further with money. But if you made it, the returns are exponential.
In order to get your business going, you would risk doing something illegal or morally not right. On one hand, if it pays off, your business may reach a state that it becomes stable and very profitable.
On the other hand, if the manoeuvre doesn’t pay off and you lose your reputation, you end up where you are right now, a person without much reputation.
But then, losing even more reputation might make your situation far worse than worse.
The Payoff for Making Continuous Risky Life Decisions is Poor
Byrne points us to Verdad’s research that people who blindly buy stock options lose money over time.
The chart below shows a hypothetical index that implements a textbook portfolio hedging strategy with out-of-the-money put options (you can read more here)
The strategy would definitely have periods where it did well (the 3 circles). But when view from a long term perspective, it is a money-losing endeavour.
This is basically like buying critical illness insurance. You pay a premium over time. If you do not claim it, you incur more and more.
Byrne explains that like options, most of us are unaware that making life gambles are very “expensive”. If this is your only strategy to succeed in life, this is not a game to play.
But if this kind of life gamble rests in between a portfolio of different other life decisions, then this may not be so bad. This is provided the rest of the life decisions tend to be more conservative.
Making a gamble here gives you a possible exponential upside but if the gamble does not work out, it will not create financial ruin for your family and yourself.
Why Very Successful People Tend to be More Risk-Averse in Decision Making
The situation changes for people who are really successful.
Byrne explains that these people know that they lucked out to be so successful. Note here, I am not trying to diss the effort they put in. Byrne explains that deep down, these folks know what a large part of their success in life is due to factors that if not present, they would not achieve what they do.
For example, they were born in a country where there are ample resources, to parents that have resources, managed to study well enough to get into a private college in a field that is in demand, and successfully get entry into a tech job that became their calling card.
These are the people in consulting, big law and increasingly in technology.
Byrne explains that if we line people up and wanted to tell the 90th percentile from the 50th percentile, that is not too difficult. But if we wish to tell the 99th from the 97th, that is quite hard.
These winners tend to be risk-averse.
They see their past successes as partly random. They see that future variances are likely to be worse off than where they are currently.
So in terms of career and business, they won’t risk it.
My Perspective: Our Behavioural Tendency Has an Effect on What We Do
I find that Byrne tries to explain to us why people would make or not make decisions with a wide range of outcomes.
But I do find that like options, which is a form of speculation or investing, our behaviours do influence whether we will make those decisions or not.
Our poor risk perception and our low-risk tolerance may make us take the opposite route, even if we are down and out and the options present themselves.
Even if life is tough, we may choose the more risk-averse route.
On the other side, those who lucked out in life may have better risk perception, where they understand certain bets may look good, calculated bets, they will make it.
But I do observe that what Byrne explains is similar to a lot of things we observe in this world.
The Wallstreet Bets folks would dare to put their entire paycheck or stimulus check on call options on some stocks.
If you lose that stimulus check, how poorer would life be? But what if this bet works out?
I observe that those who are successful in life through their career or business choose the largely risk-averse decisions in life. They could buy Tesla shares, but if you look at the majority of their wealth, it will be in one or two landed properties.
They would have gone against what Byrne describe if they would bet a large part of their net wealth on these decisions with highly variable outcomes.
When was the last time a highly successful friend do something like that?
Byrne has an underlying message.
Just like the options market, in certain fields, successful people tend not to bet on volatility and if there are quite a lot of successful people, it may be worth it for you to make decisions that have more volatility in the outcome.
In options terms, the out-of-the-money options are cheaper, and the risk versus reward is there.
But his message is also more of us normal folks think that life is about to get more exciting versus the normal folks who think life tends to be boring.
I think what Byrne says is true about my life.
If what I have is well cherished because I think I made a series of successful decisions that can turn out otherwise, I tend to make more risk-averse decisions in the future.
But as I gain more resources, I realize that I need a decision portfolio that is more balanced in terms of risk. If the majority of decisions made has pretty fixed outcomes, I have to balance it up with certain decisions that have variability in outcomes.
If those decisions made don’t work out, there are consequences but not too big that they will hurt life. But if they work out… then it could vastly improve my outcome.
A portfolio of balanced risk prevents ruin but also prevents us from being plagued by the fear of missing out.
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