’s confidence in his estimations. Taleb was up at a whiteboard by the door, his marker squeaking furiously as he scribbled possible solutions. Spitznagel and Pallop looked on intently. Spitznagel is blond and from the Midwest and does yoga: in contrast to Taleb, he exudes a certain laconic levelheadedness. In a bar, Taleb would pick a fight. Spitznagel would break it up. Pallop is of Thai extraction and is doing a PhD in financial mathematics at Princeton. He has longish black hair and a slightly quizzical air. “Pallop is very lazy,” Taleb will remark, to no one in particular, several times over the course of the day, although this is said with such affection that it suggests that laziness, in the Talebian nomenclature, is a synonym for genius. Pallop’s computer was untouched and he often turned his chair around so that he faced completely away from his desk. He was reading a book by the cognitive psychologists Amos Tversky and Daniel Kahneman, whose arguments, he said a bit disappointedly, were “not really quantifiable.” The three argued back and forth about the solution. It appeared that Taleb might be wrong, but before the matter could be resolved the markets opened. Taleb returned to his desk and began to bicker with Spitznagel about what exactly would be put on the company boom box. Spitznagel plays the piano and the French horn and has appointed himself the Empirica DJ. He wanted to play Mahler, and Taleb does not like Mahler. “Mahler is not good for volatility,” Taleb complained. “Bach is good. St. Matthew’s Passion!” Taleb gestured toward Spitznagel, who was wearing a gray woolen turtleneck. “Look at him. He wants to be like von Karajan, like someone who wants to live in a castle. Technically superior to the rest of us. No chitchatting. Top skier. That’s Mark!” As Spitznagel rolled his eyes, a man whom Taleb refers to, somewhat mysteriously, as Dr. Wu wandered in. Dr. Wu works for another hedge fund, down the hall, and is said to be brilliant. He is thin and squints through black-rimmed glasses. He was asked his opinion on the square root of n but declined to answer. “Dr. Wu comes here for intellectual kicks and to borrow books and to talk music with Mark,” Taleb explained after their visitor had drifted away. He added darkly, “Dr. Wu is a Mahlerian.”
Empirica follows a very particular investment strategy. It trades options, which is to say that it deals not in stocks and bonds but with bets on stocks and bonds. Imagine, for example, that General Motors stock is trading at $50, and imagine that you are a major investor on Wall Street. An options trader comes up to you with a proposition. What if, within the next three months, he decides to sell you a share of GM at $45? How much would you charge for agreeing to buy it at that price? You would look at the history of GM and see that in a three-month period it has rarely dropped 10 percent, and obviously the trader is only going to make you buy his GM at $45 if the stock drops below that point. So you say you’ll make that promise, or sell that option, for a relatively small fee, say, a dime. You are betting on the high probability that GM stock will stay relatively calm over the next three months, and if you are right, you’ll pocket the dime as pure profit. The trader, on the other hand, is betting on the unlikely event that GM stock will drop a lot, and if that happens, his profits are potentially huge. If the trader bought a million options from you at a dime each and GM drops to $35, he’ll buy a million shares at $35 and turn around and force you to buy them at $45, making himself suddenly very rich and you substantially poorer.
That particular transaction is called, in the argot of Wall Street, an out-of-the-money option. But an option can be configured in a vast number of ways. You could sell the trader a GM option at $30, or, if you wanted to bet against GM stock going up, you could sell a GM option at $60. You could sell or buy options on bonds, on the S&P index, on foreign currencies, or mortgages, or on the relationship among any number of financial instruments