Optionality

hi our topic for today is optionality i'm again talking about taleb's book anti-fragility and i want to discuss this idea of optionality because i think it's very important very important for philosophy and ethics and political philosophy as well as for organizational ethics for business for in general living your life so why does he focus on optionality well one way of looking at this is to say we want to be able to detect fragility we want to be able to detect opportunities for anti-fragility we want to be able to make ourselves gain from volatility from disorder from things that could potentially harm us so we not only don't want to be fragile we want to look out for things that might make us fragile and avoid them or at least mitigate them but we also want to look out for opportunities and how do we do it well he gives us some guidelines and i think they are important guidelines no matter what you're interested in doing no matter what your profession no matter what your goals are in life if you have them and maybe if you've watched the last video you don't have them you've given up the teleological fallacy and realize better not to have a goal better not to have a plan here's the motto you might say for this one things are too complicated to be expressed in words and i think that's a fundamental point in fact if i had to summarize my own philosophical view in one motto it might be that things are too complicated to be put into any kind of formula to be expressed in words to be expressed in a theory and so that complexity is something that is part of life it's essential to life it's essential to the life of every individual person but also to every organization to every group of people so how do you deal with that sort of complexity that's the question he's focusing on and it is in part a prudential question about how to thrive in a world you don't understand that's immensely complex but it's also a question of ethics how do you act ethically in a world you do not understand it's a complicated question and a tricky question because we typically think either that we understand consequences well enough to make some judgments on the basis of that or that we understand people's intentions or characters well enough to make some moral judgments on the basis of that if we don't understand any of those things then what basis is left for morality well by the end of the book i think telem answers that question and what we're going to look at here is part of that answer so let's start with what he calls the philosopher's stone more technically convexity bias how to be stupid now why do i say how to be stupid most of us don't have a goal of being stupid but the idea is this there's a sense in which we are inevitably stupid in life why well because we're in a world we don't understand the quest for knowledge is something we can make a lot of progress on but on the other hand we're never going to get close to understanding what's going on around us what's going on with other people what's going on with the world things are far too complex so what do we do how can we thrive in a world we don't understand where we're really relatively ignorant and relatively stupid given the complexity of the world here's the key idea optionality is a substitute for intelligence it is a substitute for knowledge it gives us a way of taking advantage of our own ignorance of our own stupidity of the opacity of this complex world now what does optionality mean what is he talking about essentially there are two rules he says now he's going to elaborate that a little more later but initially for the philosopher's stone there are two rules the first is don't be so stupid that you're hurt yourself a lot of damage is irreversible so don't harm yourself look for situations with limited downside and where there's a big downside protect yourself try to play it very safe in those domains but then look for those opportunities where the there's a big upside we don't have to if we recognize those options and function as opportunists be able to predict which of those are going to work out well we don't know what investments of time effort money and so on are actually going to pay off but we can find ourselves taking risks in the various areas where we have more to gain than to lose and then all we need is the intelligence to take advantage of the good outcomes now why is this a philosopher's stone why is it something that can turn stupidity into intelligence and turn ignorance into success it's because we don't have to make the judgment before the fact we're making the judgment after the fact we have to know when to take our profits we have to know when we're actually benefiting and say okay good there's the upside this one is paying off we take advantage of that take advantage of the upside when it occurs we have to have the intelligence to do that if we invest in a bunch of stocks that are risky then some of them rise dramatically and we do nothing until they fall down again well yeah there were opportunities we didn't take them so the key idea is not to know which stocks will perform well in advance it's to be able to recognize the gains and take them when they happen now that's harder than some of you might anticipate as anybody who's invested in the stock market knows it can be true in life too there are opportunities and sometimes they start paying off but will they continue or is it time as it were to sell and stop doing that it's not at all easy to tell when that moment comes and so it does require real rationality real intelligence to do that part but it requires much less than anticipating which of those investments is going to pay off before the fact we just have to recognize the payoffs after the fact and take advantage of them much of this section of the book is devoted to what taleb calls the green lumber fallacy what is the green lumber fallacy it's based on his story about a guy who was the greatest expert in trading green lumber he had no idea what it was he thought it was lumber painted green he didn't realize that no it just means freshly cut lumber green because it hasn't been cured or dried or any of that and so he didn't know what it was but he was very good at trading it and something similar happens in his story about fat tony fat tony becomes immensely wealthy by anticipating that the first iraq war was actually going to decrease the price of oil rather than increase it everybody else was betting on an increase he thought no i don't see why i think they've already built that into the price there are already too many people anticipating that so when war was declared what happened the price of oil fell by about a half and fat tony got very rich now was it because he had brilliant insight there he knew that was his case well in part but part of it was simply that he was making lots of judgments and he said look you know you don't get that many opportunities whereas one of your judgments and one of your risks pays off big when it happens seize the day take advantage of that that's what we have to do here we have to think what's really essential in this situation and it may not at all be what we think we don't have to really know what green lumber is we don't really have to know anything about iraq or the price of oil or middle east politics or anything else we can just think i think people are overestimating the danger here or hey i i can see when demand seems to be rising and falling i don't know what that this product is but nevertheless i can kind of judge when people whatever when they don't and so in short don't mistake the thing for the function of the thing if you're concerned with prices focus on the price don't worry about what it's the price of and conversely if you're worried about the essence of the thing don't worry about some symbol for it or representation of it or something else distinguish the thing from the function of the thing now it sounds very simple when you put it that way who would fall for that but people fall for it all the time and here's how they do it they mistake the narrative about something the story about something the concepts we use to analyze something for the thing itself and so they get too tied up in the narrative they get too tied up in the concept in the talk and not in the thing itself and so they start over emphasizing articulated knowledge and under emphasizing actual ability to do things and so one might also call this the narrative fallacy or something like that you get attached to the narrative rather than focusing on the thing itself the thing that really matters and so you focus on the wrong thing now there are a variety of ways in which this happens one of the ways is that people value talking more than doing and it's a mistake i have seen so many people over the last decades of my life make judgments about people's character about their intelligence on the basis of how well they can talk and this astounds me the fact that somebody can talk about something well doesn't mean they can do something well george bernard shaw said those who can't do teach well that's rather cynical and something that uh you know i quote as a teacher making fun of myself a bit but there's a sense in which we could say this is right doing and thinking are two different things and doing and talking about doing are two different things the people who can do something are not necessarily the people who are good to talk about it the people who talk about things and may be very effective at talking about things and explaining something can't necessarily do it themselves it's rare that somebody can both talk about the thing understand it verbalize it articulate it and also do it that well lots of people don't do it and if we think about certain spheres of activity we don't even expect it do we expect people to be able to talk about cooking theory or plumbing theory the best plumber may not at all be able to talk to you about plumbing or explain exactly what's going on here great plumbers don't study plumbing theory and great chefs don't read books about cooking theory they may look at recipes they will go to school and learn certain techniques but they don't have to know the biochemistry of what's going on in the kitchen and similarly the plumber doesn't really have to understand the engineering principles involved and so all of this is really very far separated from being able to talk about anything so here's a way to summarize the point optionality having options having opportunities that is a substitute for intelligence it's a substitute for knowledge optionality is asymmetry plus rationality asymmetry because you've got to place yourself in a position where there are opportunities where you have more to gain than to lose and then rationality because you have to recognize the gains and take advantage of them when they occur now the implication of the green lumber fallacy is that we mustn't confuse theory and practice yogi berra said in theory there's no difference between theory and practice in practice there is and indeed there is a huge gap between theory and practice when it comes to actually doing something you can read all the books you want about playing the piano it doesn't make you a great pianist you can read all the books you want about music theory and i've got a lot of them right here it doesn't make you a great composer and so the theory is different from the practice now it might seem in theory that there isn't one yogi berra has a deep insight here because in theory you can say this is what bach was doing and doing counterpoint that way here's exactly what paco bell was doing and you have kind of a theory that explains it but that's different from doing it presumably pachelbel and bach were not thinking about that theory of counterpoint but they had some theory they had some theory heuristics and guides but the theory was developed after the practice not vice versa so we tend to think in terms of theory being applied in practice that's typically not how it goes that's not how scientific innovation typically goes it's not how business innovation typically goes it's not that we have a theory and then we apply it to practice we have practice we're trying to understand it figure out how to get better at it how to teach it and then we develop theories and i don't want to say that theory is irrelevant theory is important partly to get better partly to recognize dimensions we hadn't thought about before and hadn't been aware of partly to help educate people and get them up to speed faster in what we're doing but in the end it isn't a substitute for the kind of skill the kind of practical wisdom as aristotle would put it that's involved in actually knowing what to do knowing what to do can't be reduced to knowing that certain things are the case and the fallacy of equating them is a version of that green lumber fallacy taleb stresses that activity has a way of stripping things down to the simplest model of things the simplest model that can be used in practice so don't worry about elaborate theories worry about some guidelines some heuristics some rules of thumb that are helpful and he closes this section of the book by giving us four examples of these heuristics these rules of thumb that he recommends the first one is rank things by optionality don't rank them by average payoff don't rank them by other kinds of considerations don't try to anticipate exact consequences instead rank them by optionality in other words say what gives me the greatest opportunities if you think well this is going to pay off but it doesn't give me much opportunity for gain reject it go for the ones that present you lots of choices present you lots of opportunities second prefer open-ended to closed-end payoffs you want to limit the downside you want closed-end downsides so you want to try to put yourself in situations where you don't have that much to lose but you want a lot to gain and preferably an unlimited amount to gain you'd like to be in a situation where the sky's the limit with respect to the upside so look for situations like that prefer those skies to limit open-ended gains to limited gains third rule invest not in business plans but in people this is something i've done throughout my entire academic career not investing in monetary terms except for the 10 years that i was actually a chairman and played a key role in hiring and other matters like that instead it's a matter of investing in the people just by saying these are the people who seem to be really smart here these are the people who seem capable those are the ones who are going to be able to take advantage of opportunities when they arise be around those kinds of people learn from those kinds of people they're the ones who will actually teach you in part how to recognize opportunity how to recognize the gains you want to take advantage of they'll teach you the skills you need to succeed in that profession or in life in general so try to find the people around you who are doing interesting things and who are best at taking advantage of opportunities don't worry about the details of what they're working on i often tell students if you're thinking about which courses to take don't worry about the course look at the professor who is doing interesting stuff who is thinking interesting things who teaches it well and actually the teaching it well is probably the least important of those some of the courses i got the most out of in graduate school were the ones taught by people who were known to be not very good teachers and indeed they weren't stellar they weren't brilliant teachers they couldn't explain things all that well but their ideas were terrific were they dressing them up and selling them in a very showy fashion no they were just laying out the ideas but the ideas themselves were fantastic and so i could recognize those are people flashy or not who know how to take advantage of ideas track the person finally make sure you're barbelled that is to say make sure you've got more to gain than to lose make sure that the asymmetries are favorable to you in the sense that you are not very susceptible to negative black swans but quite open to positive black swans make sure there are opportunities for gain that is greater than any opportunity or danger you have for loss finally i want to close with a point from nietzsche nietzsche at one point says what is not intelligible to me is not necessarily unintelligent i found over the past decades lots of people writing off other people as unintelligent as stupid when in fact they were doing something those people simply didn't understand it's very easy to think look that makes no sense that person's such a dummy when it's simply that you don't get what they're doing now sometimes that person themselves doesn't get what they're doing in the sense that they can't talk about it they can't explain it they can't give you a theory but they're extraordinarily good at it and i mentioned there are some jazz musicians i know who are like that they can't explain what they're doing they just do it and they do it extraordinarily well hang around with them and you'll start learning little tricks that help you do it better too why do they work you may have an idea you may not okay but hey it doesn't matter you learn from that master that it works the fact that you can't understand it or even that that person can't understand it maybe nobody can understand it maybe it's strictly unintelligible to everyone that doesn't make it unintelligent that doesn't mean it's something that is dumb and that you can't learn from because the world is complex because causal relationships in a complex world are opaque there's going to be a lot out there that you and everyone else find unintelligible that doesn't mean it's not important it doesn't mean that somebody who has the ability to deal with it is stupid it may well be they have a huge amount of practical wisdom they know what to do but they can't explain how they know what to do they just do they can't explain it maybe nobody can explain what the heck they're doing but that doesn't mean it's not a very important kind of practical wisdom and that it's something we shouldn't value greatly that kind of ability to do something whether or not you can explain it is key not just optionality and to rationality but to living well

Channel: Daniel Bonevac

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Length: 18min 37sec (1117 seconds)

Published: Thu Nov 19 2020