Today’s idiot and why hedge funds are a scam:
Just as lottery tickets are an ‘idiot tax’ on poor, low-IQ people who don’t understand probabilities and have high time preference, hedge funds are a tax on rich people who think such funds offer some sort of ‘edge’ to justify such high fees, poor performance, and occasional risk of the fund blowing up or the fund manager absconding with the money. The same goes for mutual funds, which also tend to lag the underlying index (such as the S&P 500) that they are supposed to track and have high fees.
To get an idea of how bad this bet is, Bitcoin would have to rise to $54,000/coin (a 240% gain from present price) by December 2018 just to break even. There is no way that is gonna happen, especially given that the total size of the crypto currency market is near $800 billion, and for Bitcoin, which has lost its marketshare dominance from 60% to 35%, to get to $54,000 would imply a total size of $2.7 trillion.
But it gets worse. Alternately, for $1 million, he could have bought 63 Bitcoins outright on the market. So for this option strategy to produce a superior return to simply buying the 63 Bitcoins and holding, Bitcoin would have to rise 340%! This is to overcome the deficit of paying $1 million for the calls. This can be visualized in the payoff diagram and seeing where the lines intersect.
But bitcoin went up 1500% in 2017, so maybe it could go up 400% in 2018? Very unlikely because growth at extreme levels resembles logistic curve, not a purely exponential one. Locally, at small values it is exponential, but becomes less so as prices rise. It’s conceivable that something to go from $1 billion to $10 billion, or even $10 billion to $100 billion, but much less likely for something to go from $150 billion to $1.5 trillion, because then you begin to run up against the carrying capacity of the overall size of the economy. This can be justified with intuition without the mathematical proof, but this concept is lost on people who give these absurd Bitcoin targets.
A common counterargument is that people play the lotto not expecting to get rich, but rather the hope and suspense of winning provides escapism and entertainment. But that does not change the fact it’s stupid. The reason is because the expected value of the lotto is negative, which means anyone who plays long enough will go broke. People who are smarter find gambles where there is a positive expected value, what is called an ‘edge’.