There are other hidden options in our story of Thales. Financial independence, when used intelligently, can make you robust; it gives you options and allows you to make the right choices. Freedom is the ultimate option.
Further, you will never get to know yourself—your real preferences—unless you face options and choices. Recall that the volatility of life helps provide information to us about others, but also about ourselves. Plenty of people are poor against their initial wish and only become robust by spinning a story that it was their choice to be poor—as if they had the option. Some are genuine; many don’t really have the option—they constructed it. Sour grapes—as in Aesop’s fable—is when someone convinces himself that the grapes he cannot reach are sour. The essayist Michel de Montaigne sees the Thales episode as a story of immunity to sour grapes: you need to know whether you do not like the pursuit of money and wealth because you genuinely do not like it, or because you are rationalizing your inability to be successful at it with the argument that wealth is not a good thing because it is bad for one’s digestive system or disturbing for one’s sleep or other such arguments. So the episode enlightened Thales about his own choices in life—how genuine his pursuit of philosophy was. He had other options. And, it is worth repeating, options, any options, by allowing you more upside than downside, are vectors of antifragility.1
Thales, by funding his own philosophy, became his own Maecenas, perhaps the highest rank one can attain: being both independent and intellectually productive. He now had even more options. He did not have to tell others—those funding him—where he was going, because he himself perhaps didn’t even know where he was heading. Thanks to the power of options, he didn’t have to.
The next few vignettes will help us go deeper into the notion of optionality—the property of option-like payoffs and option-like situations.
Saturday Evening in London
It is Saturday afternoon in London. I am coping with a major source of stress: where to go tonight. I am fond of the brand of the unexpected one finds at parties (going to parties has optionality, perhaps the best advice for someone who wants to benefit from uncertainty with low downside). My fear of eating alone in a restaurant while rereading the same passage of Cicero’s Tusculan Discussions that, thanks to its pocket-fitting size, I have been carrying for a decade (and reading about three and a half pages per year) was alleviated by a telephone call. Someone, not a close friend, upon hearing that I was in town, invited me to a gathering in Kensington, but somehow did not ask me to commit, with “drop by if you want.” Going to the party is better than eating alone with Cicero’s Tusculan Discussions, but these are not very interesting people (many are involved in the City, and people employed in financial institutions are rarely interesting and even more rarely likable) and I know I can do better, but I am not certain to be able to do so. So I can call around: if I can do better than the Kensington party, with, say, a dinner with any of my real friends, I would do that. Otherwise I would take a black taxi to Kensington. I have an option, not an obligation. It came at no cost since I did not even solicit it. So I have a small, nay, nonexistent, downside, a big upside.
This is a free option because there is no real cost to the privilege.
Your Rent
Second example: assume you are the official tenant of a rent-controlled apartment in New York City, with, of course, wall-to-wall bookshelves. You have the option of staying in it as long as you wish, but no obligation to do so. Should you decide to move to Ulan Bator, Mongolia, and start a new life there, you can simply notify the landlord a certain number of days in advance, and thank you goodbye. Otherwise, the landlord is obligated to let you live there somewhat permanently, at a predictable rent. Should rents in town increase enormously, and real estate experience a bubble-like explosion, you are largely protected. On the other hand, should rents collapse, you can easily switch apartments and reduce your monthly payments—or even buy a new apartment and get a mortgage with lower monthly payments.
So consider the asymmetry. You benefit from lower rents, but are not hurt by higher ones. How? Because here again, you have an option, not an obligation. In a way, uncertainty increases the worth of such privilege. Should you face a high degree of uncertainty about future outcomes, with possible huge decreases in real estate value, or huge possible increases in them, your option would become more valuable. The more uncertainty, the more valuable the option.
Again, this is an embedded option, hidden as there is no cost to the privilege.
Asymmetry
Let us examine once again the asymmetry of Thales—along with that of any option. In Figure 5, the horizontal axis represents the rent, the vertical axis the corresponding profits in thekels. Figure 5 shows the asymmetry: in this situation, the payoff is larger one way (if you are right, you “earn big time”) than the other (if you are wrong, you “lose small”).
FIGURE 5. Thales’ antifragility. He pays little to get a huge potential. We can see the asymmetry between upside and downside.
The vertical axis in Figure 5 represents a function of the rent for oil presses (the payoff from the option). All the reader needs to note from the picture is the nonlinearity (that is, the asymmetry, with more upside than downside; asymmetry is a form of nonlinearity).
Things That Like Dispersion
One property of the option: it does not care about the average outcome, only the favorable ones (since the downside doesn’t count beyond a certain point). Authors, artists, and even philosophers are much better off having a very small number of fanatics behind them than a large number of people who appreciate their work. The number of persons who dislike the work don’t count—there is no such thing as the opposite of buying your book, or the equivalent of losing points in a soccer game, and this absence of negative domain for book sales provides the author with a measure of optionality.
Further, it helps when supporters are both enthusiastic and influential. Wittgenstein, for instance, was largely considered a lunatic, a strange bird, or just a b***t operator by those whose opinion didn’t count (he had almost no publications to his name). But he had a small number of cultlike followers, and some, such as Bertrand Russell and J. M. Keynes, were massively influential.
Beyond books, consider this simple heuristic: your work and ideas, whether in politics, the arts, or other domains, are antifragile if, instead of having one hundred percent of the people finding your mission acceptable or mildly commendable, you are better off having a high percentage of people disliking you and your message (even intensely), combined with a low percentage of extremely loyal and enthusiastic supporters. Options like dispersion of outcomes and don’t care about the average too much.
Another business that does not care about the average but rather the dispersion around the average is the luxury goods industry—jewelry, watches, art, expensive apartments in fancy locations, expensive collector wines, gourmet farm-raised probiotic dog food, etc. Such businesses only care about the pool of funds available to the very rich. If the population in the Western world had an average income of fifty thousand dollars, with no inequality at all, luxury goods sellers would not survive. But if the average stays the same but with a high degree of inequality, with some incomes higher than two million dollars, and potentially some incomes higher than ten million, then the business has plenty of customers—even if such high incomes are offset by masses of people with lower incomes. The “tails” of the distribution on the higher end of the income brackets, the extreme, are much more determined by changes in inequality than changes in the average. It gains from dispersion, hence is antifragile. This explains the bubble in real estate prices in Central London, determined by inequality in Russia and the Arabian Gulf and totally independent of the real estate dynamics in Britain. Some apartments, those for the very rich, sell for twenty times the average per square foot of a building a few blocks away.
Harvard’s former president Larry Summers got in trouble (clumsily) explaining a version of the point and lo
st his job in the aftermath of the uproar. He was trying to say that males and females have equal intelligence, but the male population has more variations and dispersion (hence volatility), with more highly unintelligent men, and more highly intelligent ones. For Summers, this explained why men were overrepresented in the scientific and intellectual community (and also why men were overrepresented in jails or failures). The number of successful scientists depends on the “tails,” the extremes, rather than the average. Just as an option does not care about the adverse outcomes, or an author does not care about the haters.
No one at present dares to state the obvious: growth in society may not come from raising the average the Asian way, but from increasing the number of people in the “tails,” that small, very small number of risk takers crazy enough to have ideas of their own, those endowed with that very rare ability called imagination, that rarer quality called courage, and who make things happen.
THE THALESIAN AND THE ARISTOTELIAN
Now some philosophy. As we saw with the exposition of the Black Swan problem earlier in Chapter 8, the decision maker focuses on the payoff, the consequence of the actions (hence includes asymmetries and nonlinear effects). The Aristotelian focuses on being right and wrong—in other words, raw logic. They intersect less often than you think.
Aristotle made the mistake of thinking that knowledge about the event (future crop, or price of the rent for oil presses, what we showed on the horizontal axis) and making profits out of it (vertical) are the same thing. And here, because of asymmetry, the two are not, as is obvious in the graph. As Fat Tony will assert in Chapter 14, “they are not the same thing” (pronounced “ting”).
How to Be Stupid
If you “have optionality,” you don’t have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells. For you don’t have to be right that often. All you need is the wisdom to not do unintelligent things to hurt yourself (some acts of omission) and recognize favorable outcomes when they occur. (The key is that your assessment doesn’t need to be made beforehand, only after the outcome.)
This property allowing us to be stupid, or, alternatively, allowing us to get more results than the knowledge may warrant, I will call the “philosopher’s stone” for now, or “convexity bias,” the result of a mathematical property called Jensen’s inequality. The mechanics will be explained later, in Book V when we wax technical, but take for now that evolution can produce astonishingly sophisticated objects without intelligence, simply thanks to a combination of optionality and some type of a selection filter, plus some randomness, as we see next.
Nature and Options
The great French biologist François Jacob introduced into science the notion of options (or option-like characteristics) in natural systems, thanks to trial and error, under a variant called bricolage in French. Bricolage is a form of trial and error close to tweaking, trying to make do with what you’ve got by recycling pieces that would be otherwise wasted.
Jacob argued that even within the womb, nature knows how to select: about half of all embryos undergo a spontaneous abortion—easier to do so than design the perfect baby by blueprint. Nature simply keeps what it likes if it meets its standards or does a California-style “fail early”—it has an option and uses it. Nature understands optionality effects vastly better than humans, and certainly better than Aristotle.
Nature is all about the exploitation of optionality; it illustrates how optionality is a substitute for intelligence.2
Let us call trial and error tinkering when it presents small errors and large gains. Convexity, a more precise description of such positive asymmetry, will be explained in a bit of depth in Chapter 18.3
The graph in Figure 7 best illustrates the idea present in California, and voiced by Steve Jobs at a famous speech: “Stay hungry, stay foolish.” He probably meant “Be crazy but retain the rationality of choosing the upper bound when you see it.” Any trial and error can be seen as the expression of an option, so long as one is capable of identifying a favorable result and exploiting it, as we see next.
FIGURE 6. The mechanism of optionlike trial and error (the fail-fast model), a.k.a. convex tinkering. Low-cost mistakes, with known maximum losses, and large potential payoff (unbounded). A central feature of positive Black Swans: the gains are unbounded (unlike a lottery ticket), or, rather, with an unknown limit; but the losses from errors are limited and known.
FIGURE 7. Same situation as in Figure 6, but in Extremistan the payoff can be monstrous.
The Rationality
To crystallize, take this description of an option:
Option = asymmetry + rationality
The rationality part lies in keeping what is good and ditching the bad, knowing to take the profits. As we saw, nature has a filter to keep the good baby and get rid of the bad. The difference between the antifragile and the fragile lies there. The fragile has no option. But the antifragile needs to select what’s best—the best option.
It is worth insisting that the most wonderful attribute of nature is the rationality with which it selects its options and picks the best for itself—thanks to the testing process involved in evolution. Unlike the researcher afraid of doing something different, it sees an option—the asymmetry—when there is one. So it ratchets up—biological systems get locked in a state that is better than the previous one, the path-dependent property I mentioned earlier. In trial and error, the rationality consists in not rejecting something that is markedly better than what you had before.
As I said, in business, people pay for the option when it is identified and mapped in a contract, so explicit options tend to be expensive to purchase, much like insurance contracts. They are often overhyped. But because of the domain dependence of our minds, we don’t recognize it in other places, where these options tend to remain underpriced or not priced at all.
I learned about the asymmetry of the option in class at the Wharton School, in the lecture on financial options that determined my career, and immediately realized that the professor did not himself see the implications. Simply, he did not understand nonlinearities and the fact that the optionality came from some asymmetry! Domain dependence: he missed it in places where the textbook did not point to the asymmetry—he understood optionality mathematically, but not really outside the equation. He did not think of trial and error as options. He did not think of model error as negative options. And, thirty years later, little has changed in the understanding of the asymmetries by many who, ironically, teach the subject of options.4
An option hides where we don’t want it to hide. I will repeat that options benefit from variability, but also from situations in which errors carry small costs. So these errors are like options—in the long run, happy errors bring gains, unhappy errors bring losses. That is exactly what Fat Tony was taking advantage of: certain models can have only unhappy errors, particularly derivatives models and other fragilizing situations.
What also struck me was the option blindness of us humans and intellectuals. These options were, as we will see in the next chapter, out there in plain sight.
Life Is Long Gamma
Indeed, in plain sight.
One day, my friend Anthony Glickman, a rabbi and Talmudic scholar turned option trader, then turned again rabbi and Talmudic scholar (so far), after one of these conversations about how this optionality applies to everything around us, perhaps after one of my tirades on Stoicism, calmly announced: “Life is long gamma.” (To repeat, in the jargon, “long” means “benefits from” and “short” “hurt by,” and “gamma” is a name for the nonlinearity of options, so “long gamma” means “benefits from volatility and variability.” Anthony even had as his mail address “@longgamma.com.”)
There is an ample academic literature trying to convince us that options are not rational to own because some options are overpriced, and they are deemed overpriced according to business school methods of computing r
isks that do not take into account the possibility of rare events. Further, researchers invoke something called the “long shot bias” or lottery effects by which people stretch themselves and overpay for these long shots in casinos and in gambling situations. These results, of course, are charlatanism dressed in the garb of science, with non–risk takers who, Triffat-style, when they want to think about risk, only think of casinos. As in other treatments of uncertainty by economists, these are marred with mistaking the randomness of life for the well-tractable one of the casinos, what I call the “ludic fallacy” (after ludes, which means “games” in Latin)—the mistake we saw made by the blackjack fellow of Chapter 7. In fact, criticizing all bets on rare events based on the fact that lottery tickets are overpriced is as foolish as criticizing all risk taking on grounds that casinos make money in the long run from gamblers, forgetting that we are here because of risk taking outside the casinos. Further, casino bets and lottery tickets also have a known maximum upside—in real life, the sky is often the limit, and the difference between the two cases can be significant.
Risk taking ain’t gambling, and optionality ain’t lottery tickets.
In addition, these arguments about “long shots” are ludicrously cherry-picked. If you list the businesses that have generated the most wealth in history, you would see that they all have optionality. There is unfortunately the optionality of people stealing options from others and from the taxpayer (as we will see in the ethical section in Book VII), such as CEOs of companies with upside and no downside to themselves. But the largest generators of wealth in America historically have been, first, real estate (investors have the option at the expense of the banks), and, second, technology (which relies almost completely on trial and error). Further, businesses with negative optionality (that is, the opposite of having optionality) such as banking have had a horrible performance through history: banks lose periodically every penny made in their history thanks to blowups.
Antifragile: Things That Gain from Disorder Page 21
