Mark Spitznagel: content to lose money 95% of the time.

With Santa Monica's trendy beaches a block away, Mark Spitznagel and three fellow traders spend their days placing a couple dozen bets that a disastrous event will rock equity markets or cause inflation to soar. On roughly 95 trades out of 100 they lose money.

That's fine with Spitznagel. The 40-year-old founder of Universa Investments likes to compare himself to a firefighter, calmly waiting for the alarm bell to ring in his brick-lined office as Bach's cello suites play in the background and a muted television airs CNBC.

"We don't care about monthly or yearly or two years of data," says Spitznagel, who, clad in button-down blue shirt, khakis and loafers, looks better prepared for a yacht race than for doomsday. "I care about much longer returns, a necessity when dealing with rare events."

Put another way, Spitznagel says, he's in the business of "time arbitrage." By that he means the notion that in time unforeseen and unprecedented crises have an outsize influence on history--or, in the case of investors, on securities prices. Such events have come to be known as black swans. The term was made famous by Nassim Taleb in his book The Black Swan: The Impact of the Highly Improbable (Random House, 2007). It refers to the notion held by 17th-century Dutch explorers that all swans were white until they were confronted with incontrovertible evidence of the honking variety to the contrary. Recent black swans could include the financial crisis of 2008 and Japan's March earthquake and subsequent nuclear disaster.

"Surprising events can have greater impact [now than in the past] because the connectivity of the world amplifies the effect," says Spitznagel.

For five years until 2004 Spitznagel and Taleb ran Empirica, a hedge fund very similar to Universa that in its short tenure generated low double-digit returns. After Taleb became seriously ill the duo shut the fund. Taleb has since given up money management to teach risk management at Polytechnic Institute of NYU in Brooklyn, write books and advise foreign governments on his theories.

Taleb remains a fervent advocate of the importance of "tail risk hedging." This is the process of protecting portfolios against highly unlikely risks that exist at the extreme tail ends of the bell curves used to model risk probabilities. He also remains involved in Universa's research but not its day-to-day investing.

Taleb preaches to his students that investors should sacrifice the urge to maximize short-term returns by assuming too much unhedged risk. His mantra: Protect your portfolio against black swans. Part of his pitch is that investors who make money when the market is falling apart are best positioned to profit further by buying assets on the cheap near the point of maximum panic. John Paulson's housing market trades are a great example of this.

"People have a natural bias to look at returns and not to look at possible losses," says Taleb. "If you reduce big losses, your overall returns will be higher."

Spitznagel's hedges mostly involve buying far-out-of-the-money put options on equities and far-out-of-the-money calls on commodities. Such options give Universa the right, but not the obligation, to sell or buy stocks or commodities. Its puts and calls can typically be exercised up to six months at prices 20% or more below (or above) the market values of the underlying securities at the time the options are bought. That means nothing short of calamity is likely to render Universa's positions in-the-money profitmakers.

When things do go very wrong for the underlying markets, however, they go very right for Universa. As the Standard & Poor's 500 dropped 38.5% by the end of 2008, the fund increased its investors' money tenfold. Spitznagel says that investors generally allocate about 1% of an investment portfolio to fund such a "black swan protection protocol."

Such returns and general fear among investors have helped Universa grow to $6 billion in assets from $300 million when it launched in 2007. Its 15 or so investors, subject to $50 million minimums, include several sovereign wealth funds.

For small investors, Taleb says it's possible to ward off black swans using a "barbell" strategy for hedging risk. Barbell strategies typically involve balancing your investments between two extremes. In this case Taleb recommends putting 80% of your assets into relatively stable investments, like government bonds and cash, and the remaining 20% in risky securities like stocks and commodities. An example using ETFs might be iShares S&P Conservative Allocation Fund (AOK), which mixes Treasurys and TIPS with small caps, junk bonds and emerging market stocks.

Another option is to devote a sliver of your investment portfolio to inverse ETFs like the Proshares Ultra Short S&P 500 (SDS), which seeks to return -200% of the daily index movement. Caution: Leveraged inverse ETFs are best suited to day trading, since their prices are reset daily.

One popular doomsday hedge involves VIX index funds. The VIX is the Chicago Board of Exchange's Market Volatility Index, which rises during panics and other periods of high volatility. Among the most liquid VIX index funds is the iPath S&P 500 VIX Mid-Term Futures Exchange Traded Note (VXZ). This fund could provide a nice cushion during a crash if you can stomach losses while you wait. In 2010 the fund fell 14% and is down 23% so far this year.

Perhaps the most popular black swan hedge is gold, and the most liquid way to buy the shiny yellow metal is with an ETF like SPDR Gold Trust (GLD).

In July Universa intends to tap the financial adviser market by offering its own black swan ETF. The fund will mimic some of the strategies employed by its institutional-only hedge fund and will have an expense ratio of 1.5%.

Will Universa be able to repeat its outsize returns in another crash? Clifford Davis, head of equity derivatives at BNP Paribas ( BNPQY.PK - news - people ), is skeptical. "A true black swan event is by definition different from all previous crises, and markets don't react in the same way."

Spitznagel is unruffled as he sits in his office listening to classical music and losing money each day. He is ready and waiting for the next black swan to arrive.

#### Just in case A Black Swan appears

The funds below should help you hold on to--and grow--your capital in times of crisis.
Hedge | Strategy | Fund | Annual expenses per $100 | Total Return Latest 12 mths | Risks
S&P 500 | Barbel strategy | iShares S&P Conservative Allocation | $0.30 | 9.0% | Best for day traders; prices reset daily
Inflation | Foreign government (Non-U.S. inflation-protection bonds) | SPDR DB Intl Govt Inflation-Protected Bond ETF | 0.50 | 22.7 | Minimal return if inflation doesn't materialize or dollar strengthens
Inflation | Gold | SPDR Gold trust | 0.40 | 24.8 | Gold prices currently high
S&P 500 | Leveraged Short Positions on the S&P 500 | Proshares Ultra Short S&P 500 | 0.91 | -37.6 | Generates high negative returns during good times
S&P 500 | VIX or volatility index | iPath S&P 500 VIX Mid-Term Futures ETN | 0.89 | -42.7 | Best for day traders; prices reset daily
Performance through June 2. Sources: Bloomberg; morningstar.