Mar 2, 2021

How to take risks

I thought about risk a lot in 2020. It was hard not to think about risk. I thought about risk every time I put on a mask to go outside. In addition to thinking about avoiding the risk of COVID-19, I actually thought a lot about taking more risks too, but different kinds of risks.

I started trading options a lot more in 2020. The neat thing about options trading is that options are a two-sided market: there are buyers and sellers, and you can choose to either be a buyer or a seller. For a given option contract only one side can be right and makes money. The probability of being right plays a big part in how they’re priced. The higher the probability of being right, the less risk involved.

I consider myself to be risk averse. I like to play it safe. I’ve never gotten a speeding ticket. I’ve never even been pulled over. More importantly, I don’t like being wrong. It doesn’t take long before you realize that you’ll make close to no money if you always want to be right, because that involves minimal risk (see risk-return). If you want to make money, you have to take on more risk and accept that you’ll be wrong sometimes.

As I mentioned in the beginning of the post, there are different kinds of risks. There are the “COVID-19” kinds where there’s a small chance of something really bad happening, and then there are the more “options trading” kinds where it’s more likely something bad happens, but it’s not that bad. The former involves ruin, an outcome (health, financial, etc.) that’s very difficult or impossible to recover from. The latter doesn’t; whatever the outcome, you can recover from it.

Sometime last year I watched a video where Nassim Taleb talks about risk taking. He basically says you should be paranoid about risks that involve ruin, but take more risks that don’t involve ruin. That’s exactly what I was doing!

Taking risks is just decision making that involves uncertainty. For any decision, if the benefits outweigh the downsides, you go ahead with it. In some cases, you go ahead with the decision even if the benefits don’t outweigh the downsides because the downsides are tolerable. This is true of options trading: it’s a fair market, and (arguably) a zero-sum game. It’s also true of lottery tickets: on average you’re losing money on every ticket you buy, but buying a $1 ticket has minimal effect on your finances, and winning the lottery can change your life.

Something I realized (unfortunately, only recently) is that there are lots of risks that have no downside. It always makes sense to take those risks: even if you’re wrong, you don’t lose anything.

Most negotiations are like this. Ask for something better, and the worst thing that can happen is that you get a “no.” So far this year I managed to negotiate my rent down by over 10% (with very little effort) and octuple (8 times!!!) my consulting rate with no negotiation by simply asking for more. I should’ve started doing this a long time ago.

Something that surprised me recently was when someone talked about how I took risks at work. Me, taking risks…? It was about how I was one of the few people who actively got involved with POCs and customers early on. Looking back, I guess it was a risk… there was uncertainty, but I didn’t see it as a risk at all: I wanted to get involved with how deals happen and had a lot I wanted to learn. I would make that decision every time.

The last part about taking risks is how to handle being wrong. One thing I learned from options trading is that the best time to manage risk is before you take it on. Afterwards, I think it’s best to just be resilient. Building resilience early on is extremely valuable. It not only protects you against your own risks, but things out of your control too.

To summarize: take small risks, avoid ruin, negotiate more, and build resilience.

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