I’m Betting $5,000 Against War with North Korea

Let me ask you to think about something. When was the last time you heard something positive on the news? Does it encourage you or make you feel safe?

My mom called me today and asked if I was OK from all the flooding in Houston. I didn’t even know there was flooding in Houston! Nowhere I go anyway. Maybe I’m uninformed and ignorant, but everywhere I go has been fine. And yet news of flooding is what makes its way onto the news half way across the country. This is a representation of what you see on the news:

Here’s what I see looking out my window today:

Having grown up in Saudi Arabia, conversations with people in the U.S. who found out about where I grew up would always tend towards “Were you safe? Was it dangerous there?” I don’t blame them either. That’s what you’re inundated with. All you ever hear about is the bad stuff. In reality, where I grew up was probably safer than any U.S. city and even most towns. Often perception does not comport with reality.

Then you mix in politics… When does rhetoric match with reality? Even less! If you listen to the news day in and day out they’ll have you scared to death. And I’m not even exaggerating. Let’s get to the heart of what I’m talking about: North Korea.

The other day, Brian Williams LITERALLY said that on MSNBC. Skip to 0:45 on this video:

Your job is to scare people to death?! How is that not fearmongering?

Take a step back for a second. Even if you don’t like Trump, you have to realize that he’s not suicidal. I really doubt Kim Jong Un is either. Yes you have leaders that want to appear powerful and dominant, but neither side wants to be nuked.

Come on. Really. Think about it. North Korea knows they cannot win a war against the U.S. They just want to sound powerful and be respected. Think back to the Cold War. Nothing ever happened.

Why did game theory become so popular back then? Because if you make a move, your opponent will make a move in response. Each action has a response. Neither side would want the fallout (pun intended) from an overtly hostile action. In their own self-interest, neither side wants the repercussion of what would happen if they actually did something. Words and actions are two different things!

So that brings me to the bet. All this talk of sabre rattling with North Korea finally started to spook the stock market yesterday. The U.S. market, as measured by the S&P 500, fell 1.5% which is the biggest one day drop we’ve had for 2.5 months. When you look at a histogram of one-day returns, you can start to put that into context. Yesterday’s move was bigger than 96.5% of the time over the last 5 years.

That’s moderately noteworthy, but even more motivating is the market gauge of volatility. The VIX is an index that measures the short term implied volatility of the S&P 500. It’s largely seen as the fear gauge of the market. The VIX jumped 44% yesterday! Here’s where that falls on a histogram of daily VIX changes.

That is a big outlier move! 99.5% of time over the last 5 years has been less than yesterday’s spike in volatility.

So here’s the thesis: The fear of war fallout risk with North Korea will be overblown. Volatility will mean revert in the near term.

Here’s the bet: Short volatility via an inverse volatility ETN. I bought my first $2,500 of XIV yesterday and my second $2,500 of XIV today.

XIV takes a hit when volatility spikes on a day like yesterday, but trends up as volatility reverts. Take a look at how its moved over the last 5 years. The same scenario played out in August 2015. XIV has gained over 150% since then.

Looking more closely at this year only, I see it as a great opportunity to get in when people are scared. Yes war is possible, but I'm willing to bet against it 99 times out of 100. And the 100th time, you'll have more to worry about than just your investment.