Chapter 1
Downside Protection
Forty-three-year-old Jennifer Sutcliffe screamed when she saw a thick diamondback rattlesnake coiled among the flowers in the backyard of her home near Lake Corpus Christi, Texas, on Sunday, May 27, 2018.1 She and her husband, Jeremy, had been tidying up the yard before their daughter and granddaughter arrived for a Memorial Day cookout. Alerted by his wife’s scream, Jeremy grabbed a shovel and decapitated the snake. Ten minutes later, he picked up the severed head to throw it away and felt the fangs sink into his hand. Finding himself in something like a Stephen King horror story, Jeremy struggled to remove the snake’s head for almost a minute. Jennifer, a nurse, knew he needed antivenom. She helped her husband into the car and began the one-hour drive to the hospital. Along the way, Jeremy had difficulty breathing, began losing consciousness, and mumbled, “If I die, I love you.”2 Doctors explained later that he had gone into septic shock. All from a decapitated rattlesnake.
Christine Rutter, a veterinarian at Texas A&M University, understood why Jeremy needed four days in a medically induced coma and twenty-six doses of antivenom to survive. (The usual is two to four.) A severed snakehead can live at least an hour and delivers a more lethal bite than normal because the snake is in mortal danger. According to Rutter, its “adrenaline is maximized . . . so whenever they bite, they give it all they have.”3 She added, “It’s almost like a Hail Mary pass in football.”
A recent study of mating rituals in Asian spiders confirms the same behavior. The two genital appendages of the male orb web spider of the species Nephilengys malabarensis break off during sex and plug up the female to block others from copulating with her. The sterilized male partner guards the female after sex, which lasts about ten seconds, to ensure its paternity by preventing other males from loosening the plugs and slipping through. In a series of experimental trials in the laboratory, an international team of scientists showed that males without their reproductive organs, the so-called eunuch spiders, regularly defeated fully endowed rivals in staged battles that lasted about sixty minutes. The biologists concluded, “A eunuch guarding a female will respond . . . with maximal force when faced with an intruder. . . . A sterile male has no reproductive future and has nothing to lose.”4 The scientists filmed the experimental battles to confirm the aggressive behavior of eunuch spiders, so the curious can watch the uncensored videos for themselves—with the usual caution that some of the scenes may be too graphic for children.
Humans have little in common with spiders or rattlesnakes, but the survival instinct prevails among all species and often alters normal behavior. Aaron Rodgers, star quarterback of the Green Bay Packers football team, has won games with the Hail Mary pass, but that is not why he will make the Hall of Fame. He succeeds with disciplined decision-making, having learned early in his career not to throw interceptions. As he once explained: “I knew that from eighth grade, when I started playing football, and on, the only way I was going to be able to stay on the field was if I made good decisions and didn’t turn the ball over.”5 Rodgers has thrown four times as many touchdown passes as interceptions during his career, a much better ratio than superstar quarterbacks Tom Brady and Peyton Manning.6 Nevertheless, Aaron Rodgers invites the chance of being picked off by throwing his signature pass into the end zone when Green Bay trails by a few points in the waning seconds of a game. Like the rattlesnake’s severed head or the neutered spider, he has little to lose. The high upside with limited downside justifies rolling the dice because the desperate heave might notch a victory, but the otherwise certain defeat makes an interception meaningless. Rodgers’s wager has an asymmetric, or skewed, payoff: substantial reward without significant negative consequence, turning the normally disciplined leader into a gambler.
Similar payoffs often arise in widely diverse activities, including politics, war, and business, with far more impact than Green Bay’s Super Bowl prospects. History shows that the success of the American Revolution turned on such a venture. General George Washington prepared for combat like a chess grandmaster, designing tactics to anticipate his enemy’s plans. On January 4, 1776, he asked the Continental Congress to reinforce New York: “I submit it with all due deference . . . whether it would not be consistent with prudence to have some of the Jersey Troops thrown into New York, to prevent . . . the landing of [enemy] Troops at that place or on Long Island near it.”7
He followed up on March 13, 1776, with another appeal to prudence: “As New York is of such importance; prudence and policy require, that every precaution that can be devised, should be adopted to frustrate the designs which the Enemy may have of obtaining possession of it.”8 Yet on Christmas night, December 25, 1776, the general discarded caution and crossed the icy Delaware River in a daring attack on the enemy in Trenton, New Jersey.
Circumstance forced Washington’s change of heart. The British, under the command of General Sir William Howe, had defeated the Continental army in battles on Long Island and in Harlem Heights and White Plains in the second half of 1776, and sickness and desertions had thinned Washington’s ranks. A week before the battle, Washington wrote to his cousin in Mount Vernon, “Your imagination can scarce extend to a situation more distressing than mine.”9 He needed a victory to attract more recruits, adding: “If this fails, I think the game will be pretty well up.”10 On December 20 General Washington gave Congress a timetable for defeat: “Ten days more will put an end to the existence of our army.”11
Washington embraced the dangerous attack on Wednesday, December 25, 1776, because he had little choice. He understood the challenge, writing to financier Robert Morris right before the Battle of Trenton: “Some lucky Chance may yet turn up in our favor.”12 Indeed, luck prevailed, and America benefited from the gamble. George Washington crossing the Delaware may not resemble Aaron Rodgers throwing into the end zone, but they are the same.
Limited downside emboldening normally cautious people may seem obvious, but attacking Trenton in the middle of the night was not Washington’s only option. He could have withdrawn forces and waited until the spring to attack. It took guts to take the chance. Even Aaron Rodgers, with nothing at stake but a meaningless interception, needs courage with his desperate heave because three-hundred-pound defensive linemen try to pound him senseless before he lofts the pass.
Quarterback Joe Namath led the New York Jets to victory over the Baltimore Colts in Super Bowl III on Sunday, January 12, 1969. It remains the greatest upset in sports history, with the possible exception of the American men’s hockey team victory over the Soviet Union in the 1980 Winter Olympics. Everyone loves an underdog, and some evidence shows that long shots reward their betting fans because they play the game with abandon.13 Namath’s Jets did precisely that because no one respected their chances. They entered the game as 18-point underdogs to the Baltimore Colts—an unprecedented spread from Las Vegas bookmakers, who ignored Namath’s boast beforehand that the Jets would win the game outright, not just beat the spread. Few would remember his now-famous words, “I guarantee it,” had not Broadway Joe played the game of his life.14 Namath received the Most Valuable Player Award, a testament to his spunk in achieving victory against the odds and for providing long-suffering Jets’ fans since then with their only Super Bowl victory. Asymmetric payoffs encourage daring behavior, but it takes skill, conviction, and courage to exploit the opportunity.
Time pressure causes the skewed outcome for Aaron Rodgers and George Washington, but limited downside alone, even without the endgame drama, promotes bold decisions. Joe Namath played the Super Bowl without restraint because everyone expected him to lose. In the financial world, where money, rather than life and limb, is at stake, a call option shines a spotlight on loss limitation. Myron Scholes, winner of the Nobel Prize in Economics for discovering, along with Fischer Black and Robert Merton, the formula for pricing options, said, “Insuring the downside [was] how I got interested in options.”15
Most investors are cautious, dividing their wealth between cash in the bank and the stock market so they can sleep well at night. Too much in stocks causes insomnia. Nevertheless, investors embrace volatile securities when buying a call option giving the right, but not the obligation, to buy stock at a fixed price. Rights, without obligations, give call options a skewed payoff: profits increase with rising stock prices, but losses are limited to a fixed fee, called the option premium. This protection against big losses makes a sophisticated f...
