Trading Games

Hey folks, just a heads up that on the sub-sack I've started posting what I am calling "Advanced Podcast Mixed Tapes". I.e. these are short of collections of other podcasts that I've enjoyed listening to. Or maybe you might say "they're interviews" I wish I had done, but didn't. So if you want more content, mixed using the same ratios we applied to this show, then you can check out "Advanced Podcast Mixed Tapes Volume 1 and 2" on the sub-sack. I think they just wanted you to get the general idea of what "Egement". I mean, again, if you're coming, if you're eight, you know, whatever, you're 20 years old. Like, there's no reason you necessarily came across, like, expected value in this gambling sense. And it was just, hey, you should know, you should understand that this is the single most important thing about what we do. I mean, I forget who's quote that is. You take an idea and you just take it super seriously. Like, that was their idea. It was the idea that if you have an advantage and you manage your risk and you play long enough, you'll make infinite money. And the opposite is true. If you have a small negative advantage and you play long enough, you're doomed. So everything was came back to this idea. So I think that the disclancy book just captured the idea in a very succinct way. As a matter of fact, when I was told to read it, I was told to read the first chapter. Maybe it was the second chapter, but it was not even read the whole book. It was just because they just explained edge in that chapter. That was the answer to you, the interview. You're listening to "Risk of Ruin". I'm John Reader. This is episode 45. Trading Games. So, if I open the Robinhood app on my phone and click "Trader Options", the user interface offers a few amazing buttons with simple icons like an up arrow. As in, I think the price of the stock will go up or a down arrow if you think the price will go down. These little icons are fantastic because financial options are beautiful precisely because of their complex properties. I mean, as an indicator of just a ballpark for this complexity, the options pricing model, i.e. Black Sholes, resulted in a Nobel Prize. Okay, and then some other smart people have come along and said, "Actually, this model, which, again, resulted in a Nobel Prize, that this model is mispecified?" And yet, Robinhood is faced with a very difficult job of trying to get complete noobs to trade options. And so, all of the complexity has been collapsed into price go up and price go down, etc. To be fair, they also have some explainers that illustrate things like what a put spread is or what a strangle is or what a straddle is. But the whole interface kind of gives off the vibe of like, "If there was a pamphlet on the registration table for the World Series of Poker, and that pamphlet offered a ranking of poker hands, right? So before you sit with the best players in the world and torch $10,000 of your money, at least you're going to know whether a flush piece is straight." To be clear, I am not making fun of Robinhood's users. This podcast series is fully on the side of folks, predisposed to wandering to some domain they have no business in, but then they figure it out over time. No one is born a winner, no one is born within knowledge of how implied volatility and change in the underlying stock interact to affect option prices. And so on this podcast, we share a kinship with Dipshits willing to show up and be the dead money. On the long shot chance that one day they won't be the dead money, we are all these Dipshits. Also, I should say that I did not pick the example of the World Series of Poker merely for its rhetorical properties or simply because this is a gambling centric podcast. I picked that example because the people on the other side of your Robinhood trades, they think about it that way. They see the market as a game. The guess for this episode is Chris Abel-Massia. Chris has made a career of trading all kinds of markets from ETFs to silver to oil to cotton. And Chris got to start back in the day, trading for Susquahana International Group or SIG IE, one of the N Boss trading firms, you know, if you made a short list of firms that have had significant effect on financial markets, SIG would always be on that list, and in fact they are literally sometimes on the other side of your Robinhood trades. So I think that Chris's story will be interesting because he has this perspective from having been inside one of these trading firms. But the other reason that Chris's story is interesting is because the way he talks about his career in trading and the stuff he's doing today is very focused on education and learning. He is explicit. He was not born a great trader. He learned to trade. The people at SIG taught him to trade. He also wasn't ushered into this life from an early age or anything like that. I was born in '78 and you know, my parents are Egyptian immigrants who met, they're both from Cairo, they met in New York in the early 70s. And honestly, like I have pretty typical immigrant kids story, like they just cared about me being safe and secure and largely risk averse, right? To me, to them, you know, they've had plenty of risk in their lives up until that point just getting here. So for them, they were just like, hey, education is the way forward. So they emphasized education. They didn't have any money, but they sent me to Catholic school. So it was better than the local public school. So they just took that very seriously and I don't think that they had any vision about, you know, there was the whole like, you should be a doctor or a lawyer and like effectively, what I hear in hindsight, when I hear that, I'm like, you should go do something that is a lock for a decent life, right? Your floor is pretty high if you establish that. And that's all they wanted. Chris writes a sub sack that covers all of the topics that are relevant for a trader, you know, everything from counterintuitive ways that implied volatility affects meme stocks to building block ideas like adverse selection and confirmation bias. I think anyone who reads the newsletter would be hard pressed to come away from it with anything other than an impression of Chris as a very diligent person. But he says that when he was young, he was lazy and undirected. He knew that education was important. So he went to a very good high school and then he went to Cornell, but it was all kind of easy. So he just coasted along. I had a lot of interests when I was younger from everything like music, sports, drawing, you know, competing at anything. I had a lot of interest, but I didn't have any way to go any deeper on most of them. I, you know, my parents were, I was a classic latchkey kid in the 80s and my parents were always working. And the idea that you could do something after school, like a sport like that was not going to happen. There was no way because remember I went to Catholic school. So I wasn't at the school that was two miles down the road. So there was no way to go back and forth. And so I basically had this life where I would like go to school and you take the bus back. I mean, my bus driver is 45 minutes each way when I was in high school. You take the bus back and then you're at your house and there's no outlet. There's no, you know, I just watched a lot of TV and the thing is like school was, school was easy for me. So it was, but because I had no outlet, I never got that persistence muscle trained. That thing that you get when you play a sport at a varsity level in high school and you have to go to practice every day or you lift before school starts and I never had any of that. I didn't have any of that muscle. I had basically cruised right up until college. And then when you get to college, it's like, oh, everybody around you is like at least the smartest you. So you're no longer cruising. So I kind of just, I felt a little lost because I'm like the cruising is only, is not really, it's almost like I doubled down on the cruising and didn't rise up to, to any sort of persistence. And so just really, really bad habits that I just had that I never broke out of. I didn't break out of it until I got hired at SIG. When Chris was finishing college, he went to a career fair and Susquejana had a table there. Actually, Chris says that at that time, none of the job seekers really knew who this firm even was. Chris's classmates wanted to work for big investment banks, not the little known training firm with headquarters in Philadelphia. And so SIG had kind of an angle that they were using to recruit new hires. Their table said roughly, do you like to play games? Alright, so this would probably not be very surprising if you've heard this podcast before, because we have had fun managers on this show. And they came from the world of games. Games are good at surfacing people who are an actually competitive and can learn by watching. And also people who are willing to make decisions with imperfect information. So SIG's pitch was explicit in specifying the kinds of people they were looking for. Actually, I should point out, even today, there's a website, which is just a SIG games blog. And their traders who are really into chess, write about that. They also have posts about League of Legends and about decisions that NFL coaches make. Just very prototypical online nerd stuff. Well this was one way that Chris fit at SIG, because Chris also likes to play games. I used to play like a game like Thunder Road or a game like Fireball Island. Games that if they have now since then reissued for the nostalgia money. So play those and I was younger. My family would play trivial pursuit, grown up. So like on the aunts and uncles get together, they would all play trivial, which was hilarious on the high-end side, 'cause a bunch of Egyptian people plan to be able to pursue and they're like, "We're not doing it at all, "and why would they know these things?" But they would play that. And I remember being a kid feeling really happy in that environment. It was, I feel like growing up, but a lot of our life oftentimes felt like, the parents were grinding. It wasn't like this super joy. It's not like the environment my kids get today, where it's like fun and joyful. It's like, it wasn't like that. So this was like this moment that was really was happy and secure, watching them play games. And so I would always, whenever we were gonna get together, I would always be saying, like, "Hey, why don't we play a game? "Why don't we play a game?" Because that was just a happy place. And then in my high school days, in even middle school, like I started playing a little bit of warhammer with my friend across the street. Then I started a blood ball league with like a bunch of kids in the class, which is like basically warhammer or football. I was actually really into football in middle school. So I was like reading, I'd read like football strategy books and stuff like that. I thought that was all really interesting. And then high school, I just played a lot of monopoly. Actually, I talked to, I actually remember talking about monopoly in my job interview and how, like, you know, you wanna own the orange properties and all that stuff. - At the career fair, Chris chatted up the singular crooter who told him to read the David Sklansky book, getting the best of it. Sklansky is best known for writing about poker, but getting the best of it is really more like a wide-ranging, advantage handbook. Here are a few sections from the book to give you an idea of the recommended reading. Expectation and percentage edge. Mathematics of Parlies. Bays the Herem. Okay, and there are chapters on card counting, horse racing, casino mistakes, and sports teasers. Will that book turned out to be the answer key for the interview? Chris read it. Actually, he said most of the interview questions came out of the first part of the book and he got the job. Then when Chris got hired, it was not as if the gambling ideas were just discarded like fine. We know this kid understands EV. Now we'll move on to the options Greeks and never talk about gambling again. Oh no. After the recruits got hired, it was time to get their hands dirty. - When I got hired at SIG, I had never played poker really before getting to SIG and then at SIG, you really forced to play a lot. Like the minute you get hired, it's like every day after work, like you're going up and you're doing your mock trading lessons and then people just stay in the office till midnight and play poker. Like it was a totally degenerate atmosphere, but it was part of the culture, like it was considered good. So you had played a ton of poker before you ever went to training and then in training, you'd play, you'd have to do 100 hours over 12 weeks minimum. - This all happened 20 plus years ago, but we are going to spend some time on it precisely because I'm very interested in just the approach of if you want to teach someone about the niche world of trading and derivatives. How would you do it? Because it seems like there's a lot going on, right? Of course you have to teach the base concepts like how to price the actual instruments. That's a necessary but not sufficient ability. Then you also need someone who will take the right amount of risk, they can't be a complete knit and they can't be a maniac either. (upbeat music) - And then after work, you would go and you would mock trade for 90 minutes after work. And mock trading was intense because, first of all, how you performed the mock trading, just determine how fast you would go to their 12 week boot camp, which you would get a raise to 50k as soon as you got accepted the boot camp. So everybody cared quite a, and the boot camp only happens four times a year. So you're always fighting for this spot, that's three months in the next three months. So super competitive and you have to be really on and you really, back then the thing that mattered was like you'd be good at your mental math, really, really fast. And you would have to show off whether you were getting things. So all of this experience, by the time you get to trading class, you know quite a bit. You're already, I always say options are a language, just like learning, like if you're learning Spanish or something, like it takes, it takes total immersion. So, you know, I would say it took about three months of immersion on the floor, to take us to the point where you didn't have to say, like, oh, call option, okay, I'm happy when the stock goes up. And like all of that, to, you know, within three months, it's very native to you and the language of bidding and offering, it's all part of the way you think. And, you know, within a year, you're thinking an option change. It's like, you know, this is just your language at this point. So, you go to, you go to trading class and then in trading class, you get immersed in theory and case studies for four weeks and then you do mock trading for eight weeks after that. And the mock trading is four hours a day and a completely, you know, they rebuilt the trading room from the trading floor as a replica in a room and you'd go in and everybody had their laptop just like they were gonna manage trading floor and you'd stand there and there'd be a ticking stock and option chains and you have to use the technology and update the markets and it was all a very good replica simulation. So, by the time you come out of the trading class, I mean, you were, in some ways, you were already better probably than the people that were standing in the, in some of the pits. The year education was better than their probably career experience at some point. So, and then you just start getting reps with actually, taking risk and live fire and all that is a different ballgame and so they don't expect much of you. So, go in there, try not to lose a ton of money and we know that you need to go through this to figure it out. So, I don't think you walk in there. You actually you walk in there more confident than you should be. Maybe that's a good byproduct of the training and then you start to get more humble and then you really start and then from there, I think is really where you start to become a trader from that point. In the early days, Chris had to learn all of the concepts at training and then he was also a clerk responsible for a lot of administrative work. The clerks were there to support the traders and also to learn to ingest all of the detail required to run the business on a daily basis. I think this is kind of crazy in hindsight, but I mean, they take you from, you don't need to know what an interest rate is to you are trading options in a pit in one year. I mean, your life is really about nothing else for a year, for sure. Like you're going to work and the admit, first of all, the administrative work that you're doing is really valuable work. It because you're doing, you're in the nitty-gritty. It's like even, you know, when I started, I wasn't doing options, but I was doing DTFs and at the time, it's like, what was my morning routine? It was like, you got to be on the floor by 5.30 in the morning. You got to get the statements from your clearing firm and you got to figure out like, what's the basket worth? How do you price the spy ETF? And you got to make sure that your positions from yesterday are reconciled to today. You got to make sure that you're pricing the basket correctly. Like how much cash does the trustee of the ETF have? What are their share quantities for everything? Like it's all very nitty-gritty detailed work that you, it's a, I mean, it's a mix of manual and automated, but at the end of the day, it is sort of teaching you that the details are incredibly important. I mean, at the end of the day, we're trading for a penny, right? So that work, first of all, is important. A lot of the clerk's job during the day was like a lot of this pre-open and post-close work. During the actual trading day, depending on what rotation you're in, you may have had more downtime than others. And downtime meaning that you were watching your trader trade. So you'd have to go get them lunch, but most of the time you're just watching what's going on and you're supposed to start a, you're supposed to learn, like, piece together and you're supposed to watch a scenario happen and then say to your trader, why did you make that decision? Why did you do that? And you're just doing that all day long. So, I mean, you're basically being mentored 24/7 that you know, during your work day and you've gotten, by the time nine months has passed, like you've gotten so much exposure to scenarios day in and day out and the markets were very busy back then. So it was pretty constant. - I will just reiterate a point that we made earlier, which is that when Chris got started, Sig was not at all a household name. Okay, but fast forward to today, and here are some indicators of the influence that Sig has in the world. They were very early investors in the parent company of TikTok. They are one of the firms that has paid Robinhood for order flow. And so in the age of the retail trader and meme stocks, that means they are right in the middle of it all. Also, now that people are talking about sports betting and prediction markets as a quote unquote, asset class, well, Sig has a sports market making group. If you trade at Calche or various betting exchanges, you might be trading with Sig. Then the other thing is that Jane Street, which is another prop trading giant, well, their founders came out of Sig. And you know, the Jane Street people left Sig over 25 years ago, so the argument is not at all that Jane Street successes are also attributable to Sig. That's not it. It's just that a decent amount of the financial history of the last decade all gets traced back to this common source. So how did that happen? Chris says this. and Jane Street took an insight about the market, which was the eventually technology would dominate, and they just kept parling the gains from that idea over and over. So starting pay for a sig trader back then, when I got hired was 37,500, it was a standard deal. That number has went up annualized at 10% a year since then. And the question is just like, why? How does that make sense? And I think that if you rewind back to 2000 when I got hired, when you went onto the trading tour, there was so many different color jackets. There was all these firms that were made up of two or three people. I just call them wild catters, right? It's using a sort of oil analogy. But it was a very fragmented world. And then you had a few leading firms, some of which exist today. Susquehanna, by the way, sig wasn't even called sig. They were Susquehanna. But I got hired. And then Timber Hill, which we know from interactive brokers, they were down there, they were large firms on their spear leads, group one Wolverine. Like these were some of the larger firms that sort of still exist in some form. But there's so many firms that are gone, either bought or they just disappeared. The difference between the firms that lasted and the firms that didn't was that the firms that lasted basically plowed every dollar they made, which was they were making, there was crazy profits in the late 90s, early 2000s. And they had the foresight to reinvest it all into technology. Now, I think that you could, these are like things that look really, really, really obvious in hindsight. But they were, I don't think they were nearly as obvious back then. So you had a number of firm, small firms, where the founders of those firms were probably like, I'm making really, really good money. And I can just like take the money off the table, walk away. And you know, like grandkids are set for life, right? But these firms that wanted to be somebody else, be bigger, they were reinvesting in technology. And I think what's happened over time is those firms look a lot more like your Silicon Valley firms than they looked 25 years ago. And what's happening is they're competing for the same exact talent. The same person that's trying to, that open AI is trying to hire today is Jane Streets trying to hire. So the skill sets have converged. People like me that would be more of like a generalist backgrounds coming out of college have basically no chance of getting hired. And all this, because all the skill sets have converged, obviously they have to compete for the same amount of pay. And it's the story is one of leverage. I mean, we've all seen how much money Jane Streets makes per employee. I mean, is there a more outside of the large, like the FANG companies and the hyper scalers, like is there a more interesting story about like the returns to leverage the power law of talent and what that person is worth in those seats? That's the story of the last 25 years. Those firms are technology firms. So Jane is probably the best example of it because they literally were born from SIG. I mean, it was the big feature yesterday in Bloomberg on Rob Greenery. Like Greenery was at SIG until the year before I got hired, like 1999. And my, you know, my bosses were like people that became really high up at Jane Streets and their cultures of teaching were came exactly right out of SIG. I mean, it was the same stuff. I think SIG in Jane Streets kind of stood alone in terms of how seriously they took the education piece. The, so education is very expensive to deliver. You have to take experienced traders off of their posts to run these programs. You have to invest, SIG is invested a lot in the technology even of their trading, of their mock trading room. And you have to have a whole debt. It's like, you have a little dedicated university. So it's expensive to do. And you know, SIG has pretty famous for their three or non-compete. So like that's some way for them to protect the fact that they put all this money into you. But you kind of, you have to have a long view on the value of doing this to invest in these people because you're not necessarily going to be a good trader in your first couple years. It's a cliche thing, but they very seriously have a growth mindset. They really believe it's okay. I can take a person with the right attitude and like sort of like a right set of qualities. And I can turn that person into a trader. You know, they're definitely on one side of that trading place is bet, right? It's like you can be molded into a trader. Even though the work day was filled with risk taking, the traders would also play games of risk. Basically for sport, it was, in Chris's words, a degenerate atmosphere and that was considered good. The traders made side bets about the market and they made side bets about stuff that didn't have anything to do with the market. - The other thing that happens in your training days is that when you're clerking for some more senior trader who's often like three years older than you maybe, that's it. But you're basically betting on everything all the time. So like you'd be standing at your post on the, you know, on the MX and you look up and you would make markets on what the total volume was gonna, because there was the big board on the floor. So you could see, like, you know, you can see a number of important markets like this S&P futures or the total NYSE volume was that day or whatever. And you would just make markets and like what these things were gonna close at at the end of the day. So you would do this all day. You would trade, you know, fake options on all these things. But you would settle up and cash. - One of the lessons that Chris had to learn early on was the danger of putting money behind your hot takes. People who take risks for a living have this bad habit beaten out of them pretty quickly. But it is a lesson that you're only going to learn the hard way. - This was around the time, crispy cream. I guess crispy cream had went public and it was kind of maybe what we would call a meme stock today in some ways, you know, it goes public, opens up way higher than its Frank Price. And you, you know, you're 22 year old and you're like, that's stupid, that's dumb. They make donuts that, right? So I'd be like, I'm a seller of that, you know, you think you're all clever. And you're, you know, you're a senior trader is like, all right, where's your offer? And you might be like, okay, I'm offered at like last sale. And you know, they say like, I'll bid you down like 1% on it, whatever, like fine. So this thing's going to be way lower. And you would get attached to the trade and you would double down and you would double down and you would never change your opinion. You would never understand, or you, you know, like you'd go through this period of time where you didn't understand that the things that you were considering as to like what the inputs of what this are, don't map to the actual result of the stock, right? That's the, that's the meta lesson there. Because that your valuation is not what drives this thing, right? So what happened is I lost a bunch of money, paper money to this, to, to him, and an act of mercy. He said, how about instead of we settling this up in cash, why don't you take us and let me take me in like three other traders out to Nobu in Tribeca. And that, it was like, and I say it was mercy because that came out to, you know, I think the bill was probably like 1,700 bucks or whatever, which was less than what I lost, and which was at that time two months rent for me. And, but it was an act of mercy because he also knew that, hey, this, this thing of like having this assistant trader bring three established traders out to dinner was like this great opportunity for him to like hang out with these traders and these traders to be like, hey, the kid didn't wellch on his bet. Like, I think he understood that there was like a benefit to doing this as well. And, and I think that that, and it was part of like this, it was part of the culture like it wasn't, you know, they're gonna make you learn the lesson, you're gonna pay for it, but we're gonna do it in the coolest way possible. - One of the most influential books about finance of the last half century, is Michael Lewis's "Lighters Poker," which gets its title from a gambling game that the Solomon traders used to play. And, I think it's fair to say that the stories about this office poker game that are mentioned in the book kind of eventually made their way into the public perception of the long-term capital meltdown because if a few billion dollars evaporates, and the people involved have already been mythologized for their cavalier attitudes towards risk in gamesmanship, well, it's nearly impossible to not connect those dots in your mind. Okay, well, playing poker, using numbers printed on dollar bills, I mean, that seems almost responsible compared to some of the prop bets that Chris has witnessed. One bet involved the trader who proposed that he could drink 20 beers in an hour. - That was just incredibly impressive, and I was, you know, two feet from the person as they did it in the office after the close. And it was just kind of crazy to watch to me. I was like, I'm not a big drinker, so I was watching this guy drink, like he drank 20 course lights in an hour and was as cool as a cucumber throughout the entire thing and just completely unfazed by the experience. It was partially scary and partially impressive. So that was one of my favorite ones just because it was, it was so impressive to see. - According to Chris, it's actually pretty straightforward to know whether you should want any piece of these prop bets. And the way to think about it would be, This is the software that we're using. result of consideration or is it the result of pride? The other one I really liked is there is one of the founders of one of the large market making firms out there today really had a great one where he was not a college basketball player and he said that he could hit, I want to say 75% from three on 100 shots. And that market opened in the 40s and I mean he knew he could do it and him and like a group of he was buying himself and there were options being traded on himself. This is one of those bets that like you know the phone calls were coming in from the banks to place their orders to the guys on the floor like that was a big one and then he went and settled it up and sure enough like he you know he hit something in the 70s and you know and that's just the classic like you shouldn't bet against somebody that's thought something through it so they could do it if it's unlikely right. It's just like totally busy in lesson. Eventually Chris had enough success at sig that he caught the attention of another firm and they said basically if you put up those results with our money you'll end up doing quite a bit better. So he left sig. Yeah, I think it's just recognizing that I had gotten comfortable with where I was as far as I understood the market that I was trading very well. I felt like I had gotten a pretty good grasp on in general what edge was and how to really just it was just like experience like feeling a lot more it was one it was like just having a lot more confidence in what I was doing and be like having having a floor on myself and some like I had done really well at sig, especially in that last year. So financially I was like I can take a chance if it doesn't work I'll be okay. So it was part of it was just having that sort of like de-risking of my downside and wanting more upside. I mean the day it was like I knew that if I had been able to put up and I didn't but like had I had I put up a similar P&L in my year where I was working for the smaller firm I would have made multiples of what I made at sig. So it was really just wanting to get as much upside as I could now that I had felt like my downside was like relatively limited and then you know it's just a matter of you have to have you have to have a champion you know somebody is that goes to that it goes to their boss and says like hey you know this guy is steady hands. Chris has traded a bunch of different markets which kind of underlines one of the core ideas we talk about on this show you know to quote the great Gen X icon Axel Rose nothing less forever. Whatever it is you're doing today has a very good chance of getting competed away and so being flexible is important. But I asked Chris how do you know when it's time to start looking for a new market? At the time I was trading natural gas I was the person in the pit and then my partner was on the phones upstairs talking of the voice brokers we had a headset between us we can communicate and then we had a junior trader that was making the markets on the screens based upon the walls that we told him like the fair surfaces. So we were covering the market from the three angles and this was during the shale boom and so if you have a market that starts to get a lot of oversupply and a lot of excess capacity and its ability to produce you're going to kill the ball on that market. So the ball was falling in natural gas. I remember we drew a line in the sand loaded up on a bunch of Vega at like owning a bunch of options at a certain like probably like 40 ball in natural gas sort of like an all-time low was stupid because it didn't because it continued just to go lower and what we we were a little late to understand the market had changed and that this was no longer a 60 ball product but it turned out it was more of like a high 30s ball product. So we lost a bunch of money and then also with the ball being so low we said well this market has got way too many market makers in it for a 35 ball product. So we started thinking about what are we going to do. So if you know there's no future in the market you're already trading then you just go find another market right there were lots of trading pits for Christ to choose from but how would you know which one to choose. The existing market makers in these pits are not going to put up a sign that says dear competition we are making too much money and you seem like a smart guy please come here. Although there were some folks that could see every market and these people also weren't as concerned with being tight lipped. The risk managers walk in the room and you're like you're talking to them you're like what going on they're like oh man silver is doing this crazy stuff you're like is that oh is that right. Like yeah we're looking at our traders that are in there you know they might have like four traders and silver auctions pit and so they're worried about those guys risk that are that's their focus. So and the risk managers can talk about it. So you're like okay maybe we should be trading silver. So we what we did in this scenario is the electronic markets were pretty nascent at that time but they were starting to grow. So we what we did is we pointed our net gas market making infra to the silver auctions market and we started making markets on the screen and silver. We started that way and then at some point it was just like you know what I should just go get I should just go take the test and get the membership on the comets. I should just leave the natural gas pit like what my opportunity cost feels very very low right now. Leave the pit go to silver and we ended up just doing that. So we kind of got tipped off from the risk manager. The risk manager talking about there what they were focused on and we just pointed our infrastructure there and then that led to me being like we probably make sense for me but actually go in the pit even. Once you go into a new situation like you said you're walking into a hostile environment. They don't want you there. You're you know you're going to split the you're splitting the pie by one over n plus one so they don't want they want to make your life uncomfortable. But you go into that with that expectation you go in knowing you're going to lose some money you go in knowing that you are going to get stuck with some trades people don't want. You just make sure that you're you're not trading any of that stuff really big and you accept that it's tuition and what will happen is over time I think over time if somebody it's like getting a girl if you just hang around long enough right and you're you're a stand up person and you don't welch eventually people will just wake up to your to the fact that you're like a decent person. I mostly think that that works as long as you're not dealing with a sociopath and so you just hang around the rim and eventually you know you get on a trade and then that the magic day looks like this this is what the magical day looks like an epit like that you've been standing next to people you've been talking to them you formed some relationship with some people you don't know how good that relationship is yet and then one day a broker comes in and sells 500 contracts at a very attractive price and you don't get on the ticket right when it gets split up 10 guys they each get 50 contracts and one of the small traders that you've formed a relationship with says hey I got 50 of these you want 10 thank you next time you're going to do you do the same exact thing for them before you know it you are breaking into the pit. And then other times Chris found the next market by just paying attention to the personnel in the pit. Pits ebb and flow with like how good they can be how much edge there there is in them you know in the case in my oil experience that the thing was I had noticed that the heating oil and gasoline options pit had you know only 10 or 15 people in there to a small pit I was an oil options pit you're talking you're closer to 100 people in that pit. So like you know 10 or 15 people in the oil options pit if you look up the volume from the exchange there's only 3000 contracts a day trading versus you know 100,000 plus or 150,000 in oil options so that right there is dissonant right you're like wait a minute why is there like only 3000 contracts trading there but there's there's 10 to 15 guys in there and none of them are 22 they're all older guys well you mean you should be able to deduce that there's probably some money over there but the way it was on the floor you'd if you tried to ask anybody like how's it going over there I mean everybody just sandbags so nobody's going to you know you're not going to know so you're taking an educated guess like hey there's probably an opportunity over there so I would I went over to that pit and then I kind of like figured out over time how it worked and it doesn't work anything like oil options it's it's got all kinds of different nuances it's a smaller handed poker table and you have to know who's who. So earlier we talked about the kind of learning that a trader has to go through to figure out what is what you know the basics of pricing derivatives and the minutia that impacts evaluation of these various instruments but then there's another part of the education that really is never going to be written down it's beyond research it can only be learned by watching the other participants in the market. There's always this cagey game of hey this person just did this they traded something that I thought was fair value well why do they trade something at fair value and usually what happens when you notice that is like a couple minutes later it will dawn on you why they did it so you're like oh that person saw in the future a little bit how did they do that what did they see that made them see three minutes into the future. So then you're kind of like trying to reverse engineer like what is there upstairs person looking at? What there's somebody talking to them in the headset? Where, what do they see? I mean there was whole strategies that were like you find somebody that's thinking that's doing trades that look a little weird and you're like they have a different perspective. They're coming from a totally different lens and sometimes you could just form a relationship with the people and through the way they talk you can kind of start to do just like what they're thinking about and looking at. And a lot of times in those situations it's oftentimes somebody that is doing something that is very the times I'm thinking of is like they were light years ahead of everybody else and sometimes you know you can kind of figure out that they're way ahead and then you're going to you're going to you know you're going to try to figure out what they're doing but sometimes maybe their guard is a little bit down because they know that like you know what the way I'm thinking about things nobody else is thinking about this in this way. I'm not going to tell you what they're doing but you can kind of get some hints. After Chris had been a market maker and had worked in a number of pits he transitioned to a new role as a portfolio manager for a fund called parallax volatility advisors going from a market maker to a portfolio manager meant that he had to completely reorient his approach to taking risk [Music] One of the stake partners was always sort of like the the one who was hanging around the class during training and I remember he stopped the class one day and he kind of said something to the degree of like what is a good trade and his definition of a good trade was it's bid there after you buy it like that's it it's so simple with the idea of course being that you have a free role like you're wrong you just take out of it so however that definition of a good trade makes more sense when you have first of all it always makes sense like that that's always a good trade it's just not a trade that's available to every kind of party in the in the in the in the trading ecosystem because you need to have today that's called being fast really fast like technology wise back in the day it meant time-place advantage you had a membership on the floor which gave you the right to be down there which gave you what they call time-place advantage my definition of a trade could not just be that anymore because what was happening is I'm getting filled because somebody needs liquidity and it's not just that I'm getting filled it might be offered in my face after I buy it so my lens is to what the fair price for something is must change so now what happens is you're previously your P&L the way you would even think about your P&L was my trading P&L today was the sum of everything that I bought and sold minus the mark at the end of the day right so I bought something for $4 it was marked at $4.10 I made a dime on that end of the day that was the definition for the sum of that number was called your day trading P&L as to be differentiated from your position P&L which was if I took my entire portfolio coming into today what's it to remark its value today right so when you are a market maker your day trading P&L is always positive and then what happens is over time your and then what happens is like your day trading P&L is simply be positive and your open position P&Ls tend to be a little negative basically what's happening is I've collected a bunch of edge up front and then I need to like manage risk to kind of hang on to it but because of adverse selection problems and that's mostly it and then costs my positions sort of like decay in their value over time I loot not not in the theta sense just I'm losing money I'm my position over time so I need to like keep refilling it up with like good day trades when you are at a hedge fund and you're no longer the fastest and have time place advantage your edge is coming more into your willingness to warehouse larger positions for longer things that look mispriced you that things positions that have equity in them in like terms of like there's value in this wall is too cheap so what happens is your day trading P&Ls are now negative like you're you're getting marked against you every day because you're buying something and that's like offered where you bought it or it's offered lower than where you bought it and what happened but then your position P&L starts to be positive like the whole world flips on you and that transition to what's a good trade to what what is a good position to warehouse and hold is a learning process I asked Chris which of these two paradigms did he like more and he said basically it's not really up to him the idea that he would be a market maker and a physical trading pit and have any kind of advantage now is just an agronistic and so what's left for Chris is trying to find trades where he has some unique insight the ability to get on trades where you're going to get positive marks on your day trading P&L every day is downstream of really an advantage some sort of advantage today that advantage is coming from technology it's coming from better machines and better logic the thing is is that skill in other words like your it's downstream of something where you're not the value adder in the case of being the trader right it's like the the the devs are the creators of the value there right so what happens is that's the best what forum of P&L is the best sharps thing that there is is being able to like make money on day trading P&L every day and just buying buying you know buying for five and selling for five oh five all day long is the best business that exists it's just not accessible to most people and if it is accessible the value captured that belongs to the devs in the quant the other system is the discretionary trading i'm going to find things that are undervalued or sell things that are overvalued doesn't have as nice a sharp to it but it is it is the result of your own artistic output like it's your creativity that created that you have to figure that out and it didn't rely on there being great technology so i think that ultimately the second the discretionary trader is the better sort of outcome for me because i'm not going to be able to drive time place advantage anymore or technology anymore so it's almost like i don't really have a choice in my answer i started this episode talking about just the idea of robinhood traders and the tutorial screen that explains options basics like straddles and strangles and i said that we are aligned with folks that have some amount of hubris the kind of overconfidence that would lead them to try to trade against the ninjas that sig or jane treat and they're vastly superior technology okay and when i say that i do not mean you know all you need is to just dream big that's not the point almost everyone will fail at this but some people will stick with it and learn what they can and find some small part of the market where they can make some money and i think that one reason that folks like that are merely just big big underdogs and not completely drawing dead is that today there are lots of ways to learn how these markets operate and one of those ways is through chris in addition to his writing he's also done various things like trading boot camps where they bring people in and run a crash course in the concepts and also let them trade in a simulated environment i also have to say that this is not you know come to this trading boot camp and learn how to draw lines on a chart and figure out which stocks are about to break out and you'll be a millionaire i.e. the faux trader charlatan grift i think you will hear that chris is consistently brutally honest about expectations it is amazing what you can learn from watching people do this for the first time i mean one thing that's very interesting to me is how intelligence and trading i'm not sure how much of the overlap there is there it's because what i have found is people that will tend to have more like an accounting background or possibly like a more like a phd like very very well educated background they are a bit paralyzed by in the game trying to be like what's the fair price of this thing and you you you actually can't get so bogged down by that versus understanding that the fair price especially in some of these games where it can't actually be computed so you have to realize very quickly is that the fair price is the consensus price and then you're trying to find arbitrages or relative value trades that exist given that this is sort you know it's like somebody like you might say the fair price for this some contract is um eleven dollars well another might be somebody saying okay there's this spread that involves that contract and it's trading for fourteen dollars so the other leg of the contract on legs is being implied at three dollars and is it being implied bid or implied offered at three dollars and putting that together really quickly like a puzzle is sort of the skill that's the thing that you're trying to do and then there's the risk sort of like the risk the there's like a risk management piece that sits over that I have not necessarily seen that the smart that smarter people in the room figure that out quicker than sort of like somebody else in the room and I think that it's important because the skill is that you are always uncertain okay it's how comfortable are you and how calibrated are you to the uncertainty that's the thing that matters not like do I know what the fair value of this thing actually is. So when you watch people sort of mock trade, you can like pick up very quickly like, oh, that person's sort of paralyzed. Oh, that person is doing things that don't have any good basis for their behavior. They like action. Chris also has options in a litigated software, which is called Moon Tower AI. And the thing he is trying to do with that software is take investors who are used to looking at the market in terms of direction and get them to understand the effect of volatility. And also to understand the ways that trades can be constructed so that they get a relatively better price for the volatility they're buying. Right. So don't just yolo your way into calls because it's the only way you can think of to lever up your rocket ship. The thing I'm always repeating is that options are always about volatility. They're not really about direction because options algebra as like you can turn any bullish trade into a bearish trade. It's just it's just it's it's always about is the price of this option makes sense compared to the volatility of the underlying asset. And so what what I'm doing is saying an option trader has this perspective where they're making money on what they think is an option that's volatility is mispriced and that they think the underlying stock is fairly priced and there's no edge in going longer short to underlying stock. The directional traders the typical directional trader has the exact opposite lens on the world. They have an opinion about the stock. This stock is too cheap. Whatever. And they assume that the options are sort of fair. And what I'm saying is well let me give you the option lit traders perspective the point of view. And then when you go to express your directional trade which I have nothing to do with that's your you woke up that day and decided that to go longer short. I can say, Hey, based upon what you think your bullish you must have some sense of like what you think the distribution of the stock must be given that are the options a good way to express the trade or not. That's that's so it's sort of like let's look at what the option market is giving you and then you decide if you want to express the trade in that way. But for the most part I think it's best to come to it with a directional angle. There's some people that want to look at this and be like, Well, I want to be a vol trader with it. And while you could do that, I think that vault the cost structure of vault trading from home is onerous. And you know at the end of the day for trading for a penny or two pennies of edge in fall, it's going to be very hard to do that without scale. I'm not out here telling anybody that like, Hey, you're going to make 100% a month trading options. I don't believe that. So you're you're what I'm doing is saying like you have this you have an opinion on the way this stock works. And this is especially troop of professionals. Your opinion should be fairly nuanced. Like you should have some sense of like timing some sense of like how far it can go like these kinds of things. If you have these things, which by the way, as an options market maker, I have no sense of these things. I have no idea. So in to me, I'm like, wow, what an advantage it must be. The thing that you're lacking is you don't know how to take that language and turn it into options like right. So I'm just trying to help somebody do that. So they're kind of learning this language and being like, what is the meaning of the vault surface? And how does that triangulate with my opinion about the stock about its timing and its end at the, you know, you don't even have to use the word vault. This is how a lot of fundamental investors might look at it. They're not necessarily thinking of all they're saying, Hey, I think that the stocks upside looks like this. It's downside looks like this. Well, yeah, you're thinking in volume. You're just not using that language. So I'm like a the education part is I'm a translation layer sitting in there. This podcast has a certain perspective, which is what you might call the edge seeking generalist perspective. And that is going to drive the things that we are interested in. If this show were, you know, hardcore options trading focus, then the questions that I would have asked Chris would have been completely different. But because of this general's viewpoint, I E Chris's episode could be sandwiched between an episode about sports and an episode about slot machines. I see Chris as a baby step into the world of volatility. My broad view is that options trading is much easier than directional trading. So volatility is more predictable than returns. This is something all quants know. For example, it's like a pillar thing, right? Nobody knows anything about what it returns are going to be. And we can, and if you think about what a return is, like what is a volatility, it's some handicapping of how wide your range is around how volatile this thing is going to be. That is what volatility is, the volatility of the returns. Volatility is more predictable, which means that pricing derivatives are just there exactly that. They're just dera, that you're pricing something that has derived from that volatility. It should be easier to know what the price of these contracts should be worth. So one might say then why doesn't everybody go trade options if it's easier? And that's the problem is like, well, yeah, it's super zero sum. And there's a lot of smart people that have already colonized the options trading market. So it's very hard to make money trading options even though it's easier at the aggregate level than the amount of profits available to the marginal entrant is very small. During the time that Chris has been writing his newsletter, he's found himself increasingly at the center of the zeitgeist. I mean, five years ago, no normal person would have cared about, you know, selling covered calls as an income strategy or whatever. But now it really does feel like you could run into someone at the oil change place and have a decent chance. They might try to strike up a conversation about their micro strategy puts. This is both kind of cool. And also super scary. When you take into account that the preferred learning method for most humans is to first get rinsed and then realize maybe they should have attempted a slightly more sober approach. So despite the fact that Chris writes about how to learn the math of options and about behavior elements of trading. And despite the fact that a lot of this stuff is offered for free, Chris says that some people just are not going to get it. This is going to sound maybe harsh, maybe I tend to think that like, if you're going to figure if you're going to figure it out, like you're just like you just kind of are, like you just are. You're going to find what to read. You're going to find what and it's like if you're unable to like do that meta work, you're just not cut out for it. Like this is, it's competitive and it's nasty. And it's like you're like if you need to have your handheld on like figuring out like what is good content and what's not, you're already cooked. Honestly, like I really do try to be optimistic. But I think that the people that are capable do end up finding the stuff that they should be looking at. But I think on average, it probably works out that the people that are kind of like going to figure it out will end up finding the people that will have been their guides. I don't think anybody's born knowing how to do any of this. I really, I'm, you know, I'm very sigpilled in that way where I think you can learn. I don't think everybody can learn it. I don't not saying that I think you absolutely need some sort of like minimum thresholds of certain characteristics. Chris told me that he sees a problem that exists today, which is that there's a widespread rejection of experts. And he says that really is not going to work if the goal is to learn even the very top people that firms like SIG hire, you know, brilliant, brilliant people. They still have to be coachable. And so if those people have to be coachable, then everyone else trying to learn the same material probably with not even close to the same aptitude. Well, they can't start the whole thing by rejecting the idea that there's anything to learn. What does SIG do as soon as they hire somebody? They humble the shit out of them. Every single person they hire is smarter than almost anybody who ever met. Like that's literally like, but what do they have to do is like they have to cut them down a bunch of notches and be like, you see everybody else in this room. They're all trying to do the same thing you're trying to do. And by the way, you're not any smarter than any of the rest of them. So that's that's unless you can be taken down to where you're ready to learn and becoming a sponge and becoming coachable. I have said that one reason we are particularly interested in Chris is because he is so education and learning focused. Well, maybe my favorite example of that is that Chris also runs trading boot camps for his kids and their cousins. He posts pictures of these boot camps. And it looks like a table of a half dozen little years sitting around it and they're learning the language of bidding and offering. I have no care at all if they want to get into trading or investing. I just want them, I care about them being to not be suckers and I care about them to be astute in their decision making, meaning that when it comes to making the decision that they've thought about things from multiple angles. And I just think trading is like a very, it's a nice enclosed ecosystem for that practice. Like, have you thought about why that person might be bidding or offering? Have you thought about, you know, when you're in the moment, there's a lot of little lessons that kind of come out, come out. Like, for example, like your attention. What you're focusing on what's being said over here, but you've kind of figured out that this person over here just kind of like makes bad choices. You want to make sure that you're always listening to the things that might come out of that person's mouth. Even though like there's this thing going on over here. So like you got to be ready. Like you're looking over here and you're ready to yell sold over there. Like that, there's all kinds of little things like that that happen in like a game like that that I'm I feel like it's it's a bit of an instruction. There's the map. There's a little bit of math stuff in there. There's a little bit of just like reasoning from like the other person's point of view in there. There's a little bit of like where you should be where your focus should be at any one point time. So I think it's just and it's just fun. Like there's this combination of things is I think has some benefit to it. So I don't I don't really like think about it as far as like, oh, I feel like I'm giving these kids like an amazing life lesson. I'm like, hey, we're doing something really fun that happens to tickle a certain part of your mind and will probably make you I do think you're probably going to be a little bit more clever in your life from having went through this. I think that there are sort of two main themes that have been prominent through this episode, which are learning and games. And in some sense, they're kind of the same thing. Professional games players are basically getting paid to learn traders gamblers, advantage players. These are people whose compensation is correlated to how much and how fast they learn relative to their competition. And so maybe you get the selection effect where people who end up in these jobs not only are capable of completely immersing themselves in the thing, but they actually like it. Well, Chris writes, I don't know, maybe 10,000 words a week. And a lot of those words are about trading concepts. Every post is like he has a hat with all of the important ideas. And then each day he reaches in and pulls one out. So gamma scalping shadow theta calculating put call parity, how volatility drag works. And why that matters for returns. He just keeps pounding out the newsletters. Also, he explains both the underlying math and frames the math in a way that is intuitive, which he is able to do because he's been living this stuff for 25 years. Actually, Chris says the fact that he could immerse himself in this stuff. That was one of not the only, but that was one of the reasons he really liked the job. For me personally, I'm glad that I got into it because for number of reasons, like one, so like there's like the one reason where it's like if you're good at it, it's a you could make a good living. And like that's a good reason to do anything. That's good to make a good living, I think that's a good value. But the other aspects of it is that it's just super engrossing. So you're, I tend to think you are the, I have a general belief that like the more time you can spend sort of in a flow state for that buzzword kind of means, I actually think this is like a very good thing for an individual. And so you're sort of aligned doing work that you're engrossed in, you like doing it. And I think that in general that probably makes you like maybe a happier or more secure person. And then there's all kinds of benefits to that and like the way you conduct yourself in life. So just flat out, if you enjoy your job, I think that's really good. And I enjoyed the job. I mean, if you go back to basic economics, like liquidity is the basis for specialization. If there's no liquidity, we're back to bartering. So specialization and comparative advantage in trade is like a piece dividend to the world. So I think that by making markets more efficient, by pricing things tighter, you sort of like lower the cost of capital for companies. And like that story I think is very much real. I mean, you could probably argue whether it's, you know, whether the, you know, the NTHHFT trader, like marginal contribution matters or not, but like because nobody knows where those lines are, I think it's like it's like a sort of a move point. Like overall the concept is very good. So yeah, I feel very good having done it. Plus, by the way, it makes you really sharp. You're probably skeptical in the way that a scientist is skeptical. So, and I think that's generally good. I mean, the trade office that you're probably too cynical in some ways. So it might cost you up, you know, opportunities that you would have had if you were like a generally more optimistic, but overall, I think it's a very good career choice. Risk of ruin is written and produced by me. Special thanks to Chris at Belmissia for taking the time to do this interview. I'm going to put some links in the show notes so that you can find Chris a sub-stack and options analytics software and also so that you can follow him on Twitter. If you want to support the show, I really appreciate it. And you can do that by subscribing to the premium sub-stack. To get in touch with me, you can email [email protected] and you can also follow me on Twitter @afkelly. [Music] , you're welcome. [Music]