Introducing Conifers

As we begin a new year in 2020, I want to write about a new topic that I will refer to as “conifers”. Conifers are discussed in Mark Spitznagel’s book “The Dao of Capital”, to explain an unusual investment strategy. Conifers (also known as gymnosperms) are a family of plants which include Christmas trees, that compete for resources against flowering plants (also known as angiosperms). These two families of plants (conifers vs. flowering plants) have two completely different strategies for surviving and multiplying in nature. Most of the time flowering plants thrive in normal growing conditions, while conifers severely under-perform. But certain conditions cause flowering plants to get wiped out, while conifers takeover scarce resources. Spitznagel explores the conifer as a teaching tool for a roundabout investment strategy.

For today’s discussion we can think of conifers as investments that under-perform in normal times, but occasionally have an opportunity to takeover scarce resources. A good example of the conifer strategy is investing in out-of-the-money (OTM) options. Most of the time, OTM options will expire worthless, but occasionally have an opportunity to overtake resources. For example in November 2019, there was a “conifer” with a 27,500% return in one month (that’s a 275x return). I have long been fascinated with out-of-the-money (OTM) options. My brother previously traded futures and options in the NYBOT pit. And after I briefly traded Eurodollar (short-term interest rates) futures on screens in 2007, I realized that OTM options could hedge a relative-value strategy during massive market dislocations.


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Source: Yahoo Finance

But first let’s talk about 3 books: Taleb (2001), Drobny (2006), and Spitznagel (2013).

When I read “Fooled by Randomness” by Nassim Taleb in the early 2000s, this book opened my mind to heuristics and fallacies, and how rare events can have a “life-changing” impact. At the time, I was learning to play small-limit poker in the underground casinos in New York, and so I was familiar with probabilities and expected values. I understood math in the context of poker strategies. But Taleb was talking about something different than “hitting a poker draw with pot odds” … he was talking about the equivalent of winning the World Series of Poker (an unlikely event that would be a life-changer). Taleb had built a career investing in “black swans”, which is almost like an extreme version of venture capital (where a single investment could return the entire value of portfolio). “Fooled by Randomness” is where the OTM options topic all started for me. I still think this book is Taleb’s best work, with “Antifragile” as my distant second favorite.

I also read “Inside the House of Money” by Steven Drobny around the same time, and the interviews with Jim Leitner and Christian Siva-Jothy made a huge impression. Leitner talked about buying long-term OTM currency options for future “drift”, and writing a butterfly option but cutting off the tail-risk of negative interest rates (years ahead of his time). Siva-Jothy talked about the explosive returns of Eurodollar (short-term interest rate) futures, and avoiding “negative gamma trades.” That interview was the first time I even read about the concept of gamma in options. Between Taleb and Drobny, there seemed to be a global macro community that understood how to use OTM options for trading ideas. I was hungry for more knowledge on OTM options, but I didn’t know how to implement these ideas into my own strategy.

Mark Spitznagel, “The Dao of Capital”, was a former business partner of Taleb. Spitznagel’s book had 2 main takeaways for me: (1) his “conifer” analogy, and (2) his chapter on “Robinson Crusoe” explained why OTM options could be paired with a equity buy-and-hold core strategy. This book started to bring together the concepts into a clearer picture. As a side note, I also understood why my career had taken strange turns, in the context of the conifer strategy. Just as conifers survive by retreating to a rocky inhospitable niche, I started to view investing in OTM options as a rocky inhospitable niche that provide rare opportunities acquire other scarce resources.

Macro Investor Sentiment

Before diving deeper into the conifer strategy, it is worthwhile establishing some context on the global macro investor sentiment now (end of 2019, beginning of 2020). Some investors are nervous about the future despite a strong 2019 market performance. As a example of investor nervousness, below is an excerpt of a Jeff Gundlach interview with Yahoo Finance in December 2019:

Well, 2019 looks really strong when you look at global stocks and bonds and gold and bitcoin and just about everything. But you have to remember that it came off an extremely arbitrary point, year-end [2018] was a very low point because the 4th quarter of 2018 was incredibly weak. So if you look at things in a broader context, things are kind of turning around.


What has helped 2019, no doubt, was the massive u-turn by the Federal Reserve. It’s really hard to believe how things have changed over the last 12 months in terms of the Fed’s outlook and their behavior. A year ago, the Fed was in automatic ‘QT’ [quantitative tightening] and they said so in the December conference, that they would be on automatic-pilot QT no matter what the data said. And then the markets tanked. They also said they were going to have sequential rate hikes in 2019 and 2020, and that changed a few weeks later too, because the markets were tanking.

And then all of a sudden, we went not only into “no more quantitative tightening”, but in response to the repo markets dust-up back on December 17th, and some other subsequent dust-ups, we see the Fed is kind of doing quantitative easing part 4, but they don’t want to call it that. They’re using semantics, saying “well we’re not doing it for long-term interest rates, we’re only doing it for overnight money and short-term interest rates,” but they’re still expanding their balance sheet. And that has driven the market for sure, I think, it forestalled the market settling back down in the second half of this year [2019] because of the quantitative easing that they’ve begun.


But what’s interesting is that the bond market seems to be showing some trouble signs. The dust-up in the repo market basically to me shows that the Fed has manipulated interest rates to a level that the market really does not accept. Because if you can’t float overnight money at a level of the Fed Funds Rate, it means that the national demand isn’t there. Which reinforces my thesis that in the next recession, absent the Fed doing massive monetary purchases, interest rates at the long-end of the curve would probably go up because of supply problems. I’ve been talking about this for a long time, that the growth in the national debt is substantially higher than the growth in nominal GDP. It’s pretty amazing when you think about it, we talk about how the economy is so good, in terms of employment it’s true, but in terms of other things, the economy isn’t that good. And if you weren’t expanding the national debt at all, if you were just keeping it constant, we would actually have negative nominal GDP right now. So it’s kind of a sobering thought that the entire expansion that we’ve had in the recent several few quarters, is all debt-based. The national debt and the deficit as a percentage of GDP are at levels that historically have been associated with the depths of a recession in terms of stimulative policy.

So I think 2019 has turned out to be one of the greatest easiest years ever for investors. Just about anything, just throw a dart, and you’re up 15-20%, not just in the United States, in global stocks as well. I think that the pattern that the United States outperforming the rest of the world has already come to an end.


I think in the next recession the dollar will fall because of the deficit problem in the United States, and investors would be better served to own foreign stock markets in dealing with the next recession.


The yield curve is no longer inverted. A lot of people think that is happy news about averting a recession. But the way history works, is that the yield curve inverts, and it did earlier this year [2019], and then actually the Fed starts easing because they realize the inverted yield curve is actually giving us information. And people breathe a sigh of relief, but actually the curve always de-inverts, turns positively sloped, before the front edge of a recession. So I actually put that in the category of being suggestive of a recession in the next 12 months, not averting a recession in the next 12 months.


The fact that 2019 has been really good is just a better reason to play defense because the next opportunity is going to be in corporate credit. You never have the same crisis twice. But if you look at the growth of the corporate bond markets, more than twice the size in the United States as it was in 2006. And as we know, through the prism of 2009, people said “that debt was really ridiculously high, we never should have allowed that to happen”. Well now it’s twice as big. And we have zombie companies that are allowed to keep going because of these artificially low interest rates. And the corporate bond market is probably significantly over-rated, which sounds a lot like sub-prime in 2006. Some of them were rated AAA and they fell to 20 cents on the dollar. Obviously it didn’t deserve a AAA rating.

Right now there are leverage ratios in the investment-grade corporate bond market that suggest that nearly a third of corporate bond market probably should be rated junk right now. AT&T is one of them, but they’ve been given a pass, because they say “well we know that we have excessive debt, it’s kind of imprudent, but we know about it, and so we will be addressing that problem in the future.” And they’re being given a pass. Well when the recession comes, there won’t be any idea of addressing these leverage ratios, they’re just going to get a lot worse, when the recession comes. And you’re going to see en masse downgradings of the investment grade corporate bond market. And trust me, when a BBB rated bond gets dropped down to a B rating, the price doesn’t go up, the price goes down. That I think will lead to a very significant divestment of a lot the naive money that’s gone into the corporate bond market.


I view investing as [piecing together three dimensional puzzles]. That basically you have moments that there’s incredible opportunity, and you can actually fit together a portfolio that has high return potential with very low risk. And those are the great moments, that was 2009, 2010, 2011. And you have times when there isn’t that much of an opportunity set, like right now. And you can’t really put together a no-risk portfolio with a high return. If you want to get a high return, you have to take a ton of risk right now. And I don’t like that, I don’t like risk, so we wait for opportunities.

Jeff Gundlach, CEO of Doubleline Capital, Yahoo Finance Interview, Dec. 4, 2019

So if I believe Jeff Gundlach’s analysis, I should be looking for investments that benefit from:

  • contraction in nominal GDP
  • increase in long-term interest rates
  • normalization in short-term repo markets
  • increase in non-dollar equity assets relative to dollar assets
  • downgrading in investment grade corporate bonds

But rather than looking for portfolio defense (e.g. increasing cash balance cushions, lowering leverage ratios by paying down debt), I am looking for conifer opportunities to provide insurance-policy-style returns in the event of a major market dislocation.

Dao of Capital (Conifers)

Spitznagel has incredible insights, as does Taleb, but it takes a lot of effort to sort through exactly what he is trying to say. There is a lot of content, and trying to understand the point requires a few re-reads. But here is a short excerpt about the conifers:

For conifers, growth is a patient process that takes tenacity and grit, and most successful with (and even requiring) a roundabout strategy, with slow early stages that create the structure for subsequent fast and efficient development.


It is not that conifers prefer rocky, acidic, sandy, waterlogged, and other low-quality soils; indeed, when they are planted and cultivated in better climates with more fertile conditions, conifers thrive. However, in order to avoid the direct competition for scarce resources, conifers retreat to inferior soil, wind-battered ridges, and low-lying areas where water collects, leaving the prime site to the faster growers.


They withdraw to where others cannot go and then act when conditions suddenly shift and an opportune moment arises, such as after a wildfire.

The Dao of Capital by Mark Spitznagel

So I interpret his general point to be that during normal times, the traditional investment opportunities are difficult to find. However during market dislocations, traditional investment opportunities become attractively priced … so how does one build up sufficient investment capital to be deployed during future periods of market stress? This is the question at the heart of the conifer strategy.

Small Data -> Medium Data -> Big Data

In the data science community, there is a distinction between the size of data sets, because different tools work better in different situations. For example, any problem that can be solved using a spreadsheet is probably is a “small data” situation. Any problem that requires multiple servers to be solved, is probably a “big data” situation. Any problem that can be solved on a single computer but requires something more powerful than a spreadsheet is a “medium data” situation. Working with options data is somewhere between a “medium data” and a “big data” situation. Let me explain why.

Every day, there is a steady stream of options data available to purchase. I use a simple subscription of end-of-data data, which means for options traded on 2019-11-01 and 2019-11-29, the dataset includes 697,901 options related to 4,227 tickers. Trying to analyze this data with a spreadsheet will likely crash a typical laptop. Trying to analyze this data with a language such as Python takes a few minutes. Medium data.

Trying to analyze an entire year of stock option data, would likely require multiple servers, for example AWS-EMR/Spark or Dask. Big data.

Black Monday (1987)

Here is one of my favorite interviews with Nassim Taleb. Taleb is speaking to Bloomberg’s Erik Schatzker about October 16, 1987.

I was at First Boston and I was an options trader. I was trading lots of things, mainly fixed-income options and currencies. And currency options were extremely inexpensive at the time, during that period, for some weird reason, particular for out-of-the-money options, for options that were remote. So I had accumulated a few of these. I had also accumulated a very large amount of out-of-the-money options in Treasuries and in short-term fixed-income for no other reason than they were much cheaper than I had seen in the past and I was happy buying them there. So I had a large portfolio of these.


My business was buying tail options, out-of-the-money options, and waiting for a large event to happen, and trying to survive in-between. That was my business already at the time.


And I remember I had a huge delta in Eurodollars. I remember then vividly offering something on the phone, and selling it considerably higher. So the guy in the pit called Tim, I’d tell Tim sell here and he would sell much higher. It was like in Trading Places, have you seen that movie? I’ve got one, I’ve got one, it was like that, all morning I remember we were selling above our offers. You want to take time to unload your inventory. There was liquidation. And sure enough we got lifted on all our offers. And then of course came back. Interest rates came back 300 on the day or something. So that was interest rates.

Currencies went wild. The dollar of course collapsed. The dollar/yen options, we had options we had bought for $10K in inventory, they were selling for $17M. Something crazy, in yen. The thing was going. It was out of control. So the big payoffs were not in the main big currencies but the ones where the move was a big surprise like Eurodollars or the yen. Swiss francs had high volatility relative to others, it wasn’t as bad for participants.

Nassim Taleb (Bloomberg Interview with Erik Schatzker, Oct 16, 2017)

Conifer Tracking (Nov-Dec 2019)

So I have setup an automated tracking system to summarize tail options with the biggest returns over a period of time. In the future, I will post new updates. Below are a few examples:

Call options from November 2019, assuming actively trading the options, buying on 2019-11-01 at the asking price (known as “taking” or “lifting” the ask), and selling the option on 2019-11-29 at the bid price (known as “hitting” the bid). In particular, I am looking at the last column “Return”.


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To confirm the data, I review the Yahoo Finance charts for “UI” and “AMTD” during the November 2019 period.

Source: Yahoo Finance (UI)
Source: Yahoo Finance (AMTD)

Call options from Nov 2019 of S&P 500 components:


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Source: Yahoo Finance (SCHW)

Put options from Nov 2019


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Source: Yahoo Finance (BXC)

Put options from Nov 2019 of S&P 500 components:


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Source: Yahoo Finance (EXPE)

Call options from Dec 2019:


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Source: Yahoo Finance (BOLD)

Call options from Dec 2019 of S&P 500 components:


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Source: Yahoo Finance (SWKS)

Put option from Dec 2019


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Source: Yahoo Finance (CONN)

Conifer is a Speculative Allocation

I won’t be approaching the conifers in the same way as HardyStocks. With HardyStocks, I am developing a buy-and-hold portfolio to grow capital in the long-term. Instead “conifers” may occasionally have an interesting short-term speculative opportunity, but do not represent buy-and-hold. Stay tuned!

Disclosure: This article is not a recommendation. Investors should make their own determination of whether or not to buy or sell stocks or options based upon their specific investment goals, and in consultation with their financial advisor.