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Based on the ideas of Nassim Taleb expounded in Antifragility, explores viewing everyday decisions through the lens of call options. Specifically, the potential benefit of decisions with convex payoff and detriment of decisions with convex harm are discussed.
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Options
Andrew B. Martin
IENG 6918
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Definition: Option
• An alternative which puts one in a position where most unexpected events can do limited harm and some unexpected events can provide potentially unlimited benefit.
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Outline
• Characterization and definition
• Examples
• Implications
• Summary
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Example: Party - Option
• “Drop by if you are around”
• Something better comes up we can take advantage of it
• Something unexpected and bad happens all we stand to lose is our night
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Example: Party - not an Option
• “Are you going to be there?”
• Something better comes up, we can take advantage of it but suffer damage
• Something unexpected and bad occurs I lose my night and then some
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Definition: Unbounded
• Y = x2 is unbounded above. Y goes to infinity as x goes to +/- infinity. It is also bounded below as Y can never be less than 0.
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Extending Unboundedness
• Y: outcome; x: conditions
• Unbounded gain: by choosing some possible conditions we can make the outcome as good as we can imagine.
• Bounded loss: regardless of conditions the outcome cannot exceed a known magnitude.
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An option puts you in a position where your potential
gains are unbounded and your potential losses are bounded.
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Example: Rent Controlled Apartments
• Rent can only increase so much
• Housing Market Grows: my rent only increases by known amount
• Housing Market Collapses: I can look for a better, now cheaper, apartment
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Example: Rent Controlled Apartments
• I am insulated from potentially harmful unexpected events.
• I can take advantage of some other unexpected events.
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Definition: Obligation
• A decision alternative that has bounded potential gains and unbounded potential losses.
• The opposite of an option.
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Example: Getting into Debt
• Bounded gain: accomplishing the purpose that motivated taking out a loan.
• Unbounded loss: unquantifiable potential damage can be inflicted on you in having keep up with debt payments.
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An option puts you in a position where some
unexpected events can benefit you, and most other
unexpected events can only do limited harm.
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The Role of the Unexpected
• Unexpected events have a disproportionate impact on our lives
• Consider stock market crashes
• These events have the potential to inflict irrecoverable damage
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We choose alternatives that are options because we do not want to be irrecoverably
damaged by unexpected events, and, on occasion, we
want to benefit from them.
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Where do we find these options?
• We must actively hunt them out!
• Recall Dr. Barzilai’s Dutch friend’s son.
• We need to know the qualities options possess so we can construct them.
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Summary Page 1/3
• Options are alternatives that put us in a position where our potential gains are unbounded and our potential losses are bounded.
• Another way to look at this is to say they place us to take advantage of some unexpected events, and such that most others can only do us limited harm.
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Summary Page 2/3
• Unexpected events can be much more harmful than those we expect. Choosing options insulates us from getting irrecoverably damaged.
• That is, suffering a loss so devastating it compromises the range of decisions we have to consider in the future.
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Summary Page 3/3
• We must look for options!
• They will not always be apparent.
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Cheers
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