December 5, 2024 • 25 mins
Steve Sosnick is now Chief Strategist at Interactive Brokers, which entails writing about and talking about key developments in financial markets. But his options market experience spans decades, with stints in risk management, market making, trading model development and optimization, and prop trading. In this eye-opening MoneyShow MoneyMasters Podcast episode, he draws on those experiences to provide critical insights about the current market environment – and how traders and investors can best navigate it.
We start by discussing Steve’s history in the options market, and how he transitioned from an in-the-trenches to public-facing role at what is now called Interactive Brokers. Next, he shares his observations about this market – including what’s causing it to “slouch”...why for some time it has been “going up because it’s going up”...and how the only debate left is whether stocks are “phenomenally expensive, bubbleicious expensive, or just plain old expensive.” That said, Steve characterizes himself as more cautious than fearful – and advocates INSURING against the tape rather than FIGHTING it.
We move on to discuss how to accomplish that, including one simple step you can take – and a more involved strategy that uses options. Regarding the latter, Steve says that once you figure out how much “insurance” you need, you should consider a couple of different tactics to combat time decay, sidestep the need for constant re-hedging, and otherwise avoid being “pushed into a decision” by market developments. We end with a discussion of what else Steve will cover at the 2024 MoneyShow/TradersEXPO Las Vegas, scheduled for Feb. 17-19 at the Paris Las Vegas. Click here to register: https://www.lasvegasmoneyshow.com/?scode=061246
We start by discussing Steve’s history in the options market, and how he transitioned from an in-the-trenches to public-facing role at what is now called Interactive Brokers. Next, he shares his observations about this market – including what’s causing it to “slouch”...why for some time it has been “going up because it’s going up”...and how the only debate left is whether stocks are “phenomenally expensive, bubbleicious expensive, or just plain old expensive.” That said, Steve characterizes himself as more cautious than fearful – and advocates INSURING against the tape rather than FIGHTING it.
We move on to discuss how to accomplish that, including one simple step you can take – and a more involved strategy that uses options. Regarding the latter, Steve says that once you figure out how much “insurance” you need, you should consider a couple of different tactics to combat time decay, sidestep the need for constant re-hedging, and otherwise avoid being “pushed into a decision” by market developments. We end with a discussion of what else Steve will cover at the 2024 MoneyShow/TradersEXPO Las Vegas, scheduled for Feb. 17-19 at the Paris Las Vegas. Click here to register: https://www.lasvegasmoneyshow.com/?scode=061246
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:05):
He's ad fifty four new highs for the S and
P five hundred this year, and we still have a
little under a month ago. We're seeing powerful momentum in
a wide range of market sectors. The Washington investors largely
shrug off scary sounding geopolitical headlines. It is all that
a good thing are the risks that markets are not
appreciating or anticipating. Today's money Show Money Master's podcast will
(00:26):
feature in an all new guests weighing in on these questions.
He's Steve Sosnik, Chief strategist to Interactive Brokers. Steve, thanks
for joining us.
Speaker 2 (00:34):
Thanks so much for having me. I'm very excited to
be joining.
Speaker 1 (00:37):
Yeah, great, Steve. I haven't had you on the podcast previously,
So why don't you start by talking a little bit
about your background in the business. What it is you
do at Interactive Brokers.
Speaker 2 (00:46):
Sure, my current title is chief Strategist Interactive Brokers. As
you mentioned in your introduction, I came about it through
a long career in trading. I started at Solomon Brothers,
you know, in the late eighties. Was I was a
training class or two behind Michael Lewis just you know,
(01:08):
so I went through that so those of you who've
read Liars Poker, you kind of know what my life
was like. The first year or so of mine in
the business. I was there for a few years in
one of those like you know, late eighties, early nineties
kind of moves Lehman Brothers poached by Department, which was
kind of a cool thing at the time, but not
(01:29):
maybe the necessarily the best, but was well before the
firm imploded. But you know, that was when I learned
the lesson you don't necessarily take a job just because
just because they pay you more. So I was there
for a couple of years, then went to Morgan Stanley
and realized that my real passion was for doing stuff
for algorithmic type of training and developing trading models rather
(01:50):
than the customer facilitation. And so when the job came open,
this would have been December nineteen ninety five, when I
learned about an opening at this option trading firm called
timber Hill, which was basically an index option trading firm
that had just got into equity option market making, and
(02:11):
they knew what they were doing in terms of electronic training,
but they didn't have a lot of people with relevant
equity risk management experience, and so I basically signed on
with timber Hill as their equity risk manager, basically working
at headquarters what was then Westchester, New York now Greenwich, Connecticut. Basically,
(02:32):
we had these models and we were sending out, you know,
we had prices that we were sending to our traders
who were on the floors at that point, and they
would you know, you know, basically be making markets based
on the prices we would send them. They would the
orders would the orders would get executed, they'd get sent
back into our model in Greenwich, and we would be
constantly readjusting the model. And you know, obviously that firm,
(02:55):
that little, relatively small firm, grew into what was at
one point the largesttions market making firm in the world.
And along the way, we changed the name to match
the small venture of of a you know, brokerage firm
that that that uh, you know, Thomas Batterfy developed just
a sort of as a way to you know, ensure
(03:16):
that that we might be able to get order flowed
for our market making. And thus it Directed Brokers became
the name of the company, and so and I've been
there ever since. Now. At some point, you know, i'd
be you know, I've you've been in the business a
long time now, I did not. I deliberately kept a
very low profile. When you're when you're a proprietary trader
(03:38):
with a pretty you know, helping manage a pretty successful model,
you don't want to be out there too much. You know,
it doesn't behoove you to to to make too much noise.
But you know, I'd made some content obviously, been in
the business a while, and at one point my my
friend Steve Sears, who I knew from when he worked
at the Exchanges, I was writing the the Striking Price
(04:01):
column for Barons and went on vacation one week and said,
have you ever tried writing a column? I said, no,
but I'll give it a try, and you know, got
you know, permission to do so, and I guess it
went well, so we asked me to do it again.
And you know, it's sort of like in the spirit
of the old Tonight Show. I became kind of the
(04:21):
permanent guest host for lack of a better word, which
which I which continues to this day. I did. I
literally wrote the current issue of his column and the
current issue of Barons. That's that's on newsstands now or
or you know on the web now. And you know,
I guess if you start doing stuff like that, then
other people take notice. And so someone from you know,
(04:43):
Bloomberg said, you know, mind if we talk to you
and I talked to you know again, how to get
permission to do all this, talk to the people from Bloomberg,
and then they said, you know what we have this,
you know, would you like to come and talk about
it on TV? Okay, that's the was like a good idea,
that seems like it'd be fun, and that turned into
(05:03):
a pretty regular gig. And so I'm I'm more from
proprietary options trader and market maker and specialist and and
you know, managing the risk. Basically my main role at
the my main role in our options market making was
I was specialist in several hundred different names, mostly financials.
I ran our Canadian business, and most importantly, I was
(05:26):
pretty much the guy responsible for making sure we didn't
blow up. And so I say that part, that part
works pretty well. At least they're not blowing up, and
you know, but then as we started to de emphasize
options market making because it was not you know, it
was not a the analyst did for a public company
(05:47):
point of view, don't love I don't love market making
because it's it's very variable. We never had a down year,
but we had up and down quarters, and they couldn't
model that. And so when the proprietary business was was
phased out, and actually later the US business was sold
to Sigma, I stayed behind because at this point I was,
(06:08):
you know, public facing and basically spending most of my
time writing about and talking about markets, primarily option markets.
But I have a very broad mandate and so here
you find me.
Speaker 1 (06:22):
Great, Well, it's a it's a long and winding road
how we all end up where we're going. So I
appreciate the background there. Great to hear. Now I want
to ask you, you know, Stephen, this market. I mean,
let's talk about what I was introducing there. I mean,
you know, we are saying new high after new high,
we're seeing volatility. And I love the term you used
in your recent commentary slouching here. What's going on and
(06:42):
where do you see things headed?
Speaker 2 (06:46):
This is very much of a momentum driven market, and
you know you alluded to it in your intro and
it's very it should be obvious and evident to anybody
who's paying attention that it's some at some level, it's
it's going up because it's going up, and that's in
many reasons a great time to be trading, but often
are very poor rationale for investing. And that's why in
(07:10):
my you know, in the most recent column that I
alluded to Forbearons, it was basically, don't fight the tape,
but ensure it. And my feeling here is by several
several different measures were getting stretched. You know, you can
pick your fundamental pick your fundamental measure, and it's expense,
and the market's expensive, whether it's phenomenally expensive, bubblicious expensive,
(07:35):
or just plain old expensive. You know that that's a
matter of some debate. And what I will acknowledge is
is a fund as someone who's paid attention to fundamentals
for decades, they're they're not a good timing indicator. You know,
stuff can be cheap for for years or more. Stuff
can be expensive. You know, the old adage market can
(07:57):
remain irrational longer than you can remain solvent. I'm not
saying we're at irrational levels. Let me let me be
very clear about that, but I do think you know,
after two years of sequential twenty percent plus gains and
and a point where the let's call it the earnings
yield on the market the eat a pe ratio, which
(08:19):
is very simplistic measure, but you know, in some ways
the most obvious one where the where the earnings yield
is lower than the than the you know, than the
treasury bond yield, you might want to start thinking about
maybe we maybe we've kind of run our course. And
it's very interesting because we had that furious rally after
(08:40):
the election, it's understandable why. But lately we've really been
for the most part kind of grinding around. And that's
where sort of the slouching term came in because it
you know, what I see in a lot of different
days is you know, like you know, taping this. We're
taping this on Tuesday. So yesterday, Monday, we had, you know,
(09:00):
the markets go up, not particularly with any great conviction.
They sold off overnight because there's some news in France.
US investors are very good at ignoring news from overseas,
and so they did once again, and the mag seven
went up. But you have actually more stocks declining than advancing,
and you do see that pattern a lot of times
where as long as the right stocks go up, it
(09:22):
doesn't really matter that you know that this big breath
expansion that we had could be fading. So in my
and also quite frankly does is there anybody right now
who's the saying that who fears a bear market? You
don't hear it? And so as a contrarian, you know,
I do. I again, I always respect the message of
(09:44):
the market, but I do always have in the back
of my mind be greety when others are fearful, and
fearful when others are greedy and people are greedy, and
so I'm not necessarily fearful, but I'm cautious fair enough.
Speaker 1 (09:58):
You know, when I talking to people that you know
are listening to financial TV. The main reasons to hear
behind the rally you've got, you know, business friendly policy,
given the election results you've got. You know, some people
looking at seasonal strength you typically have this time of year,
and some people talk about hope for FED cuts, I
mean not just later this month into twenty five. Any
thoughts on those individual factors, I mean, do you think
they're being over anticipated or overweighted, or do you think
(10:21):
it's fair to be bullish based on some of these drivers.
Speaker 2 (10:25):
There, but prices move at the margin. So have you
told me anything that's not factored in? And that's not
a knock on you, that is just right. I mean, okay,
business friendly climate, we priced that in in the run
up after the election. Rate cuts. We've been until recently,
where it'll be interesting to see what the next dot
plot says. The market's been way ahead of the Fed
(10:48):
in terms of expecting rate cuts. Finally sort of changed
a little bit. We'll see if the fedbacks off, because
you know, the inflation numbers haven't been as friendly as
the market had hoped, and the jobs numbers, fortunately are
not as bad as feared, so that may or may
not be priced in. You know a lot of people saying, oh,
(11:09):
what are the great reasons to invest in the market?
Is you know the S ANDP is expect you know,
we're expecting double digit earnings growth for US ANDP next year. Well,
that means it's priced in already. So what so this
is my problem. Momentum can last a long time, and
if you think from a factor's point of view, which
I'm not an expert on factors, so I'm not going
to hold myself out there saying, you know, I'm the
(11:30):
factor's guy. But when you break the market down into factors,
the one that has been most consistently outperforming, so to
speaks momentum. And so to me, what that means is
if we're all expecting call it, fifteen percent ise earnings
growth for the S and P next year, that's phenomenal, okay,
(11:50):
But that means it's relatively priced in, because that's in
there in the price. And that's why you see stocks
freak out when companies guidance doesn't mean eat the numbers.
It no longer really matters whether or not you have
to you have to beat your number. But in an
environment where seventy five percent or eighty percent of the
companies beat their number, that's a necessary condition for a rally,
(12:14):
not a sufficient condition for a rally. So people are
starting to look beyond the EPs, and they have been
looking more into revenue for some time, but now it's
all about guidance. If a company even gives a whiff
of bad guidance, because you really have to adjust your
forward numbers. And so this is where I sort of wonder, like, Okay,
(12:34):
what's left, what's what good news. What good news. There's
a lot of good news priced in, which is which
is why, which is why. I'm not saying the market
is a you know, a bubble or anything of that nature.
But what it means is the easy you know, the
easy yardage has been gained. You know. Now now now
(12:57):
it's more of a now we have to grind it out.
We have to make sure that we actually do get
the Goldilock's economy or the soft landing, whichever scenario you
prefer to say, which allows you know, for moderating monetary
conditions at the same time you at the same time
allowing pretty robust profit growth. If we're talking about three
(13:18):
percent real GDP growth, which you know, by the way,
doesn't in my mind, doesn't necessarily scream we need more
rate cuts. But let's say we have three percent real
GDP growth. Let's say inflation is in the two to
three percent range, So that's called six percent nominal growth. Okay,
So where does the other nine percent growth come in?
(13:39):
For the S and P five hundred, it could you know,
it's it's tough to you do. It's very difficult to
bet against you. American management. They're very clever, they're good
if they're good at finding ways to improve. But again,
this tells me that there's you know, we're getting to
the point where I worry that we that we have
to draw to an inside right straight, I've mixed like
(14:03):
one hundred different metaphors in here. I apologize.
Speaker 1 (14:06):
That's okay. I mean Las Vegas, we're going to be
trying to do a poker night, So there you go,
that would fit right in. Uh So, let's let's talk
about that. You mentioned the thesis, and I love that
headline in the Baron's column. You know, don't fight it
and sure and sure against it. So what does an
investor do if your sort of you know, thesis plays
out here? What's what's the best move as an investor
or trader?
Speaker 2 (14:28):
Well, my, my, you know, in general, always the first
thing to do to d risk. People always ask what's
the best thing I could do to d risk? And
that is take some money off the table in an
environment where short term interest rates are basically you're getting
you're actually we're not used to this where you're getting
some real interest rates for a change. If you're nervous,
take some off you know you've got. Now I understand
(14:51):
there's tax, there's tax consequences to it, and that's probably
why through the end of the year there's not going
to be a huge pressure on the market barring some
of oxogynous factor, because no taxable investor, no taxable investor
really wants to be selling now. Number one, just because
tax policy usually says, so you know, get your losses
(15:13):
out before the calendar terms and get and get your
you know, wait for your gains till after the calendar terms. Secondly,
I think people will want to see, uh, what the
momentum is in terms of any potential tax cuts or
at least whether you know, I think that the one
thing that really did justify the reason really, by the way,
is the idea that you know, differing tax policies between
(15:36):
the Democrats, the Democrat and the Republican administration. So there
there's there's that factor to it. But you know, maybe
don't put more money in at this point. If you're ready,
you know, if you're ready where you are, then the
next thing is and I that's why I use the
term insurance and the strategy I laid out in the article.
(15:56):
And it's not one size fits all, and I never
you'll you'll never get that from me. It's it's just
not something I do because everybody feels Differently, figure out
what your risk tolerance is and be honest about it,
because you know, I think a lot of times you have,
you know, like think about the day or in early
August when you know, when there was the carry trade
implosion and people freaking out. Some of that was for selling,
(16:20):
but you know a lot of people were getting very nervous.
And if you were very nervous on a day like that, well,
that to me to if you get nervous on a
on a you know, relatively routine draw down or something
slightly bigger, that's how that should be your signal that
you're carrying too much risk. So figure out what your
risk tolerance really is. Are you trying to ensure against
the five percent draw down, You're trying to ensure against
(16:42):
the ten percent draw down, You're trying to insure against catastrophe,
fifteen twenty percent, that kind of thing. Figure out what
that is. So that's your that's your deductible if you
want to think about it in those terms, right, you know,
like when you're buying insurance on your house, am I
willing to? Am I willing? To bear a one thousand
dollars loss before my homeowners kicks in my loan to
(17:03):
bear five thousand. We're willing to do a ten thousand.
You know, if you're in the you know, you know,
maybe you want to you know, maybe maybe you want
almost self insured. But you understand my point there, So
then you figure out and as with insurance, the lower
the deductible, the higher the premium. So what it means
is you have to buy options that are closer to
(17:25):
the money and therefore more expensive, more cash outlay. Now,
one thing we have seen is there it's at money
volatilities are relatively low. We see that from VIX and
we see them from other different measures. The skews are
actually relatively steep, meaning that out of the money puts
have they're implied volatilities. If not having risen there, they've
(17:49):
certainly remained firmer than the app money volatilities. So you're
not alone and putting on this trade. But that's kind
of why I advocate then looking out two to three months.
And there's a reason for that, and it has to
do with decay and it has to do with my
thesis about short dated options. We've all fallen in love
(18:10):
with short dated options. There there's you know, I don't
have the current statistics in front of me, but I
think options under seven days to expire or certainly majority
of the option volume right now. But my commentary on that,
and I don't want to steal thunder from what I
want I intend to talk about in February, is those
(18:30):
options are both the cheapest and the most expensive options
on the board. And my reason for that is they
have the lowest price because they have the least time.
You know, you're not paying for any You're you're paying
for very little time premium. But the one thing I
can but decay is non linear. You know, one of
the first lessons I learned way back when when options
only expired once a month is you know, the your
(18:52):
decay falls off a cliff once you get into expiration month.
And those were those were options that were expiring two
to three weeks out. So you know, think about it
when you're when you're talking about options that are expiring shortly,
and of course on the final day, one hundred percent
of your time premium. There's very few guarantees in the
world of options. One of them is your time premium.
(19:13):
Will be gone by the end of the day if
you're you know, if you're trading an expiration day. So
that's why I say that there from a percentage, you know,
you're not paying a very high price. You're for those options,
you're paying very low premiums, which is why they're very appealing.
But as a hedge, they have drawbacks because you're you're
really fighting decay and you have to be continually hedging constantly.
(19:36):
You can't take a break, you can't not do it.
Whereas if you look out two to three months, yes
you're spending more money on the option, but you're not
really you're protected. If you have an overnight you have
an over night move. It doesn't really it doesn't really
moves in your face. Negative movement moves in your favor,
not not saying, oh rap, I now have to I
(19:57):
have to buy these more expensive options. And I then
advocate rolling them six weeks to a month to six
weeks before they expire, so that yes, you've lost some
time decay, but you haven't really hit that exponential decay period.
And it also means again you don't have to be
(20:17):
pushed into a decision. You don't have to say oh
you know, Oh man, I gotta I have to rehadge
this insurance no matter what it costs me. You're up,
you're down, it's no big deal. And remember also with insurance,
you actually don't necessarily want your insurance to pay off,
depending on what type of insurance you're buying. Certainly I
(20:38):
don't want my life insurance to pay off anytime, you know.
And realistically I don't want to put in a homeowner's claim.
I don't want to put in I don't want to
put a collision claim. Options are a little unusual because
insurance there's the concept of moral hazard. No one will
write you an insurance policy if you have an incentive
(20:58):
to make that policy pay off off, right, you know,
if you're an arsonist, good luck getting a fire insurance
policy right. In the options market, you don't know who
you're you know. I particularly this my life as a
market maker, I didn't know who I was selling insurance
to per se. Obviously there's there's rules against insider training
(21:21):
and the like, but for the most part, I don't
know who it is. You can Whereas again with insurance,
I can't ensure my house for more than it's worth.
In options, you can ensure. You can ensure your portfolio
for more than you know you can ensure yourself one
hundred and ten, two hundred. You can shure whatever you
want relative to your portfolio. But so this is why
(21:44):
if you're thinking of it as insurance, as insuring, as
buying protection on a piece of your valuable asset, which
is your portfolio, think about it in insurance terms. You
don't necessarily want it to pay off. You don't necessarily
you know, unless you're over insuring, right. You know, if
I'm ensuring fifty percent of my portfolio value against a
(22:05):
ten percent loss, I still want them. I want the
market to go up, which would mean those puts, those puts.
I'm continually buying some puts that are expiring, but I'm
giving up a little bit of my return to sleep
at night. Yeah, and so that's kind of the way
to think about it.
Speaker 1 (22:21):
Ye fair enough, you know, Steve, in the last minute
or two that we have here and you're gonna be
joining us for the twenty five Money Show Traders Expo
Las Vegas that's in February. I know markets can change
dramatically in an hour, a day, or a week, much
last a couple of months. I'm can you give viewers
a quick preview of the kinds of things you're going
to be talking about. There you talked a little bit
about the zero DT options. I'm just kind of curious
one of the things you might cover.
Speaker 2 (22:43):
I think we'll start to talk about that. I think
i'd like to talk about, you know, speculating in options
visa the hedging with options. I think we've you know,
the options markets developed. And I sound like a cranky
old man here, but options markets developed as a means
of risk transfer and hedging, not purely you know, yes,
you need speculators to make it go, but I think
(23:04):
we've kind of morphed into using options as speculative tools,
and I want to refocus people on the other characteristics
of options because I think we've we've fallen a little
too in love with the speculation and that falls into
you know, the general momentum trading. I think i'd also,
you know, depending on where we are at the time,
(23:26):
I always want to talk about the current volatility environment,
potentially talking about how correlation affects volatility. Indicies like the vicks,
which have a lot more to do with correlation and
dispersion of the S and P five hundred index, I
think than most people realize. Short answer is, if you
(23:47):
have a two stock index and both stocks move in
the same direction, that's full volatility. If you have a
two stock index and they move in opposite directions, that's
zero volatility. Obviously, it's a lot more subtle if you
tell you about a five hundred stock cap weighted index.
But there's the basic point. So so, and of course,
definitely you know how to sort of read things in
(24:07):
terms of you know, options, skews and options. You know,
to get a sense of the risk, the risk that
other people may or may not see in the market
and any given time, got it? Got it? Well?
Speaker 1 (24:18):
See if you clearly have a lot of insights to
offer and viewers, if you're watching this and you want
to learn more from Steve, he is going to be
speaking at the Money Show Traders Expo Las Vegas that's
February seventeenth to nineteenth at the Paris, Las Vegas Resort.
You find out more by clicking the link in the
video description below. Don't forget to like ris. If you
like this video, subscribe to our Money Show channel here
you'll get updates like these in between events. See again.
(24:39):
Thank you so much for joining the podcast and taking
some time out.
Speaker 2 (24:42):
Thank you so much for having me. Look forward to
seeing you in person in a couple of months.
Speaker 1 (24:45):
Perfect Take care, Take care. We'll have more interviews for
you every week, so I encourage you to subscribe to
the Money Master's podcast so you can stay up to
date with the insights from top money experts. You can
follow me on Twitter at real Mike Larson and follow
Money Show from Investing in Trading content on Twitter, Instagram,
and YouTube at Money Show. Thanks for listening, See you
(25:06):
next time.
He's ad fifty four new highs for the S and
P five hundred this year, and we still have a
little under a month ago. We're seeing powerful momentum in
a wide range of market sectors. The Washington investors largely
shrug off scary sounding geopolitical headlines. It is all that
a good thing are the risks that markets are not
appreciating or anticipating. Today's money Show Money Master's podcast will
(00:26):
feature in an all new guests weighing in on these questions.
He's Steve Sosnik, Chief strategist to Interactive Brokers. Steve, thanks
for joining us.
Speaker 2 (00:34):
Thanks so much for having me. I'm very excited to
be joining.
Speaker 1 (00:37):
Yeah, great, Steve. I haven't had you on the podcast previously,
So why don't you start by talking a little bit
about your background in the business. What it is you
do at Interactive Brokers.
Speaker 2 (00:46):
Sure, my current title is chief Strategist Interactive Brokers. As
you mentioned in your introduction, I came about it through
a long career in trading. I started at Solomon Brothers,
you know, in the late eighties. Was I was a
training class or two behind Michael Lewis just you know,
(01:08):
so I went through that so those of you who've
read Liars Poker, you kind of know what my life
was like. The first year or so of mine in
the business. I was there for a few years in
one of those like you know, late eighties, early nineties
kind of moves Lehman Brothers poached by Department, which was
kind of a cool thing at the time, but not
(01:29):
maybe the necessarily the best, but was well before the
firm imploded. But you know, that was when I learned
the lesson you don't necessarily take a job just because
just because they pay you more. So I was there
for a couple of years, then went to Morgan Stanley
and realized that my real passion was for doing stuff
for algorithmic type of training and developing trading models rather
(01:50):
than the customer facilitation. And so when the job came open,
this would have been December nineteen ninety five, when I
learned about an opening at this option trading firm called
timber Hill, which was basically an index option trading firm
that had just got into equity option market making, and
(02:11):
they knew what they were doing in terms of electronic training,
but they didn't have a lot of people with relevant
equity risk management experience, and so I basically signed on
with timber Hill as their equity risk manager, basically working
at headquarters what was then Westchester, New York now Greenwich, Connecticut. Basically,
(02:32):
we had these models and we were sending out, you know,
we had prices that we were sending to our traders
who were on the floors at that point, and they
would you know, you know, basically be making markets based
on the prices we would send them. They would the
orders would the orders would get executed, they'd get sent
back into our model in Greenwich, and we would be
constantly readjusting the model. And you know, obviously that firm,
(02:55):
that little, relatively small firm, grew into what was at
one point the largesttions market making firm in the world.
And along the way, we changed the name to match
the small venture of of a you know, brokerage firm
that that that uh, you know, Thomas Batterfy developed just
a sort of as a way to you know, ensure
(03:16):
that that we might be able to get order flowed
for our market making. And thus it Directed Brokers became
the name of the company, and so and I've been
there ever since. Now. At some point, you know, i'd
be you know, I've you've been in the business a
long time now, I did not. I deliberately kept a
very low profile. When you're when you're a proprietary trader
(03:38):
with a pretty you know, helping manage a pretty successful model,
you don't want to be out there too much. You know,
it doesn't behoove you to to to make too much noise.
But you know, I'd made some content obviously, been in
the business a while, and at one point my my
friend Steve Sears, who I knew from when he worked
at the Exchanges, I was writing the the Striking Price
(04:01):
column for Barons and went on vacation one week and said,
have you ever tried writing a column? I said, no,
but I'll give it a try, and you know, got
you know, permission to do so, and I guess it
went well, so we asked me to do it again.
And you know, it's sort of like in the spirit
of the old Tonight Show. I became kind of the
(04:21):
permanent guest host for lack of a better word, which
which I which continues to this day. I did. I
literally wrote the current issue of his column and the
current issue of Barons. That's that's on newsstands now or
or you know on the web now. And you know,
I guess if you start doing stuff like that, then
other people take notice. And so someone from you know,
(04:43):
Bloomberg said, you know, mind if we talk to you
and I talked to you know again, how to get
permission to do all this, talk to the people from Bloomberg,
and then they said, you know what we have this,
you know, would you like to come and talk about
it on TV? Okay, that's the was like a good idea,
that seems like it'd be fun, and that turned into
(05:03):
a pretty regular gig. And so I'm I'm more from
proprietary options trader and market maker and specialist and and
you know, managing the risk. Basically my main role at
the my main role in our options market making was
I was specialist in several hundred different names, mostly financials.
I ran our Canadian business, and most importantly, I was
(05:26):
pretty much the guy responsible for making sure we didn't
blow up. And so I say that part, that part
works pretty well. At least they're not blowing up, and
you know, but then as we started to de emphasize
options market making because it was not you know, it
was not a the analyst did for a public company
(05:47):
point of view, don't love I don't love market making
because it's it's very variable. We never had a down year,
but we had up and down quarters, and they couldn't
model that. And so when the proprietary business was was
phased out, and actually later the US business was sold
to Sigma, I stayed behind because at this point I was,
(06:08):
you know, public facing and basically spending most of my
time writing about and talking about markets, primarily option markets.
But I have a very broad mandate and so here
you find me.
Speaker 1 (06:22):
Great, Well, it's a it's a long and winding road
how we all end up where we're going. So I
appreciate the background there. Great to hear. Now I want
to ask you, you know, Stephen, this market. I mean,
let's talk about what I was introducing there. I mean,
you know, we are saying new high after new high,
we're seeing volatility. And I love the term you used
in your recent commentary slouching here. What's going on and
(06:42):
where do you see things headed?
Speaker 2 (06:46):
This is very much of a momentum driven market, and
you know you alluded to it in your intro and
it's very it should be obvious and evident to anybody
who's paying attention that it's some at some level, it's
it's going up because it's going up, and that's in
many reasons a great time to be trading, but often
are very poor rationale for investing. And that's why in
(07:10):
my you know, in the most recent column that I
alluded to Forbearons, it was basically, don't fight the tape,
but ensure it. And my feeling here is by several
several different measures were getting stretched. You know, you can
pick your fundamental pick your fundamental measure, and it's expense,
and the market's expensive, whether it's phenomenally expensive, bubblicious expensive,
(07:35):
or just plain old expensive. You know that that's a
matter of some debate. And what I will acknowledge is
is a fund as someone who's paid attention to fundamentals
for decades, they're they're not a good timing indicator. You know,
stuff can be cheap for for years or more. Stuff
can be expensive. You know, the old adage market can
(07:57):
remain irrational longer than you can remain solvent. I'm not
saying we're at irrational levels. Let me let me be
very clear about that, but I do think you know,
after two years of sequential twenty percent plus gains and
and a point where the let's call it the earnings
yield on the market the eat a pe ratio, which
(08:19):
is very simplistic measure, but you know, in some ways
the most obvious one where the where the earnings yield
is lower than the than the you know, than the
treasury bond yield, you might want to start thinking about
maybe we maybe we've kind of run our course. And
it's very interesting because we had that furious rally after
(08:40):
the election, it's understandable why. But lately we've really been
for the most part kind of grinding around. And that's
where sort of the slouching term came in because it
you know, what I see in a lot of different
days is you know, like you know, taping this. We're
taping this on Tuesday. So yesterday, Monday, we had, you know,
(09:00):
the markets go up, not particularly with any great conviction.
They sold off overnight because there's some news in France.
US investors are very good at ignoring news from overseas,
and so they did once again, and the mag seven
went up. But you have actually more stocks declining than advancing,
and you do see that pattern a lot of times
where as long as the right stocks go up, it
(09:22):
doesn't really matter that you know that this big breath
expansion that we had could be fading. So in my
and also quite frankly does is there anybody right now
who's the saying that who fears a bear market? You
don't hear it? And so as a contrarian, you know,
I do. I again, I always respect the message of
(09:44):
the market, but I do always have in the back
of my mind be greety when others are fearful, and
fearful when others are greedy and people are greedy, and
so I'm not necessarily fearful, but I'm cautious fair enough.
Speaker 1 (09:58):
You know, when I talking to people that you know
are listening to financial TV. The main reasons to hear
behind the rally you've got, you know, business friendly policy,
given the election results you've got. You know, some people
looking at seasonal strength you typically have this time of year,
and some people talk about hope for FED cuts, I
mean not just later this month into twenty five. Any
thoughts on those individual factors, I mean, do you think
they're being over anticipated or overweighted, or do you think
(10:21):
it's fair to be bullish based on some of these drivers.
Speaker 2 (10:25):
There, but prices move at the margin. So have you
told me anything that's not factored in? And that's not
a knock on you, that is just right. I mean, okay,
business friendly climate, we priced that in in the run
up after the election. Rate cuts. We've been until recently,
where it'll be interesting to see what the next dot
plot says. The market's been way ahead of the Fed
(10:48):
in terms of expecting rate cuts. Finally sort of changed
a little bit. We'll see if the fedbacks off, because
you know, the inflation numbers haven't been as friendly as
the market had hoped, and the jobs numbers, fortunately are
not as bad as feared, so that may or may
not be priced in. You know a lot of people saying, oh,
(11:09):
what are the great reasons to invest in the market?
Is you know the S ANDP is expect you know,
we're expecting double digit earnings growth for US ANDP next year. Well,
that means it's priced in already. So what so this
is my problem. Momentum can last a long time, and
if you think from a factor's point of view, which
I'm not an expert on factors, so I'm not going
to hold myself out there saying, you know, I'm the
(11:30):
factor's guy. But when you break the market down into factors,
the one that has been most consistently outperforming, so to
speaks momentum. And so to me, what that means is
if we're all expecting call it, fifteen percent ise earnings
growth for the S and P next year, that's phenomenal, okay,
(11:50):
But that means it's relatively priced in, because that's in
there in the price. And that's why you see stocks
freak out when companies guidance doesn't mean eat the numbers.
It no longer really matters whether or not you have
to you have to beat your number. But in an
environment where seventy five percent or eighty percent of the
companies beat their number, that's a necessary condition for a rally,
(12:14):
not a sufficient condition for a rally. So people are
starting to look beyond the EPs, and they have been
looking more into revenue for some time, but now it's
all about guidance. If a company even gives a whiff
of bad guidance, because you really have to adjust your
forward numbers. And so this is where I sort of wonder, like, Okay,
(12:34):
what's left, what's what good news. What good news. There's
a lot of good news priced in, which is which
is why, which is why. I'm not saying the market
is a you know, a bubble or anything of that nature.
But what it means is the easy you know, the
easy yardage has been gained. You know. Now now now
(12:57):
it's more of a now we have to grind it out.
We have to make sure that we actually do get
the Goldilock's economy or the soft landing, whichever scenario you
prefer to say, which allows you know, for moderating monetary
conditions at the same time you at the same time
allowing pretty robust profit growth. If we're talking about three
(13:18):
percent real GDP growth, which you know, by the way,
doesn't in my mind, doesn't necessarily scream we need more
rate cuts. But let's say we have three percent real
GDP growth. Let's say inflation is in the two to
three percent range, So that's called six percent nominal growth. Okay,
So where does the other nine percent growth come in?
(13:39):
For the S and P five hundred, it could you know,
it's it's tough to you do. It's very difficult to
bet against you. American management. They're very clever, they're good
if they're good at finding ways to improve. But again,
this tells me that there's you know, we're getting to
the point where I worry that we that we have
to draw to an inside right straight, I've mixed like
(14:03):
one hundred different metaphors in here. I apologize.
Speaker 1 (14:06):
That's okay. I mean Las Vegas, we're going to be
trying to do a poker night, So there you go,
that would fit right in. Uh So, let's let's talk
about that. You mentioned the thesis, and I love that
headline in the Baron's column. You know, don't fight it
and sure and sure against it. So what does an
investor do if your sort of you know, thesis plays
out here? What's what's the best move as an investor
or trader?
Speaker 2 (14:28):
Well, my, my, you know, in general, always the first
thing to do to d risk. People always ask what's
the best thing I could do to d risk? And
that is take some money off the table in an
environment where short term interest rates are basically you're getting
you're actually we're not used to this where you're getting
some real interest rates for a change. If you're nervous,
take some off you know you've got. Now I understand
(14:51):
there's tax, there's tax consequences to it, and that's probably
why through the end of the year there's not going
to be a huge pressure on the market barring some
of oxogynous factor, because no taxable investor, no taxable investor
really wants to be selling now. Number one, just because
tax policy usually says, so you know, get your losses
(15:13):
out before the calendar terms and get and get your
you know, wait for your gains till after the calendar terms. Secondly,
I think people will want to see, uh, what the
momentum is in terms of any potential tax cuts or
at least whether you know, I think that the one
thing that really did justify the reason really, by the way,
is the idea that you know, differing tax policies between
(15:36):
the Democrats, the Democrat and the Republican administration. So there
there's there's that factor to it. But you know, maybe
don't put more money in at this point. If you're ready,
you know, if you're ready where you are, then the
next thing is and I that's why I use the
term insurance and the strategy I laid out in the article.
(15:56):
And it's not one size fits all, and I never
you'll you'll never get that from me. It's it's just
not something I do because everybody feels Differently, figure out
what your risk tolerance is and be honest about it,
because you know, I think a lot of times you have,
you know, like think about the day or in early
August when you know, when there was the carry trade
implosion and people freaking out. Some of that was for selling,
(16:20):
but you know a lot of people were getting very nervous.
And if you were very nervous on a day like that, well,
that to me to if you get nervous on a
on a you know, relatively routine draw down or something
slightly bigger, that's how that should be your signal that
you're carrying too much risk. So figure out what your
risk tolerance really is. Are you trying to ensure against
the five percent draw down, You're trying to ensure against
(16:42):
the ten percent draw down, You're trying to insure against catastrophe,
fifteen twenty percent, that kind of thing. Figure out what
that is. So that's your that's your deductible if you
want to think about it in those terms, right, you know,
like when you're buying insurance on your house, am I
willing to? Am I willing? To bear a one thousand
dollars loss before my homeowners kicks in my loan to
(17:03):
bear five thousand. We're willing to do a ten thousand.
You know, if you're in the you know, you know,
maybe you want to you know, maybe maybe you want
almost self insured. But you understand my point there, So
then you figure out and as with insurance, the lower
the deductible, the higher the premium. So what it means
is you have to buy options that are closer to
(17:25):
the money and therefore more expensive, more cash outlay. Now,
one thing we have seen is there it's at money
volatilities are relatively low. We see that from VIX and
we see them from other different measures. The skews are
actually relatively steep, meaning that out of the money puts
have they're implied volatilities. If not having risen there, they've
(17:49):
certainly remained firmer than the app money volatilities. So you're
not alone and putting on this trade. But that's kind
of why I advocate then looking out two to three months.
And there's a reason for that, and it has to
do with decay and it has to do with my
thesis about short dated options. We've all fallen in love
(18:10):
with short dated options. There there's you know, I don't
have the current statistics in front of me, but I
think options under seven days to expire or certainly majority
of the option volume right now. But my commentary on that,
and I don't want to steal thunder from what I
want I intend to talk about in February, is those
(18:30):
options are both the cheapest and the most expensive options
on the board. And my reason for that is they
have the lowest price because they have the least time.
You know, you're not paying for any You're you're paying
for very little time premium. But the one thing I
can but decay is non linear. You know, one of
the first lessons I learned way back when when options
only expired once a month is you know, the your
(18:52):
decay falls off a cliff once you get into expiration month.
And those were those were options that were expiring two
to three weeks out. So you know, think about it
when you're when you're talking about options that are expiring shortly,
and of course on the final day, one hundred percent
of your time premium. There's very few guarantees in the
world of options. One of them is your time premium.
(19:13):
Will be gone by the end of the day if
you're you know, if you're trading an expiration day. So
that's why I say that there from a percentage, you know,
you're not paying a very high price. You're for those options,
you're paying very low premiums, which is why they're very appealing.
But as a hedge, they have drawbacks because you're you're
really fighting decay and you have to be continually hedging constantly.
(19:36):
You can't take a break, you can't not do it.
Whereas if you look out two to three months, yes
you're spending more money on the option, but you're not
really you're protected. If you have an overnight you have
an over night move. It doesn't really it doesn't really
moves in your face. Negative movement moves in your favor,
not not saying, oh rap, I now have to I
(19:57):
have to buy these more expensive options. And I then
advocate rolling them six weeks to a month to six
weeks before they expire, so that yes, you've lost some
time decay, but you haven't really hit that exponential decay period.
And it also means again you don't have to be
(20:17):
pushed into a decision. You don't have to say oh
you know, Oh man, I gotta I have to rehadge
this insurance no matter what it costs me. You're up,
you're down, it's no big deal. And remember also with insurance,
you actually don't necessarily want your insurance to pay off,
depending on what type of insurance you're buying. Certainly I
(20:38):
don't want my life insurance to pay off anytime, you know.
And realistically I don't want to put in a homeowner's claim.
I don't want to put in I don't want to
put a collision claim. Options are a little unusual because
insurance there's the concept of moral hazard. No one will
write you an insurance policy if you have an incentive
(20:58):
to make that policy pay off off, right, you know,
if you're an arsonist, good luck getting a fire insurance
policy right. In the options market, you don't know who
you're you know. I particularly this my life as a
market maker, I didn't know who I was selling insurance
to per se. Obviously there's there's rules against insider training
(21:21):
and the like, but for the most part, I don't
know who it is. You can Whereas again with insurance,
I can't ensure my house for more than it's worth.
In options, you can ensure. You can ensure your portfolio
for more than you know you can ensure yourself one
hundred and ten, two hundred. You can shure whatever you
want relative to your portfolio. But so this is why
(21:44):
if you're thinking of it as insurance, as insuring, as
buying protection on a piece of your valuable asset, which
is your portfolio, think about it in insurance terms. You
don't necessarily want it to pay off. You don't necessarily
you know, unless you're over insuring, right. You know, if
I'm ensuring fifty percent of my portfolio value against a
(22:05):
ten percent loss, I still want them. I want the
market to go up, which would mean those puts, those puts.
I'm continually buying some puts that are expiring, but I'm
giving up a little bit of my return to sleep
at night. Yeah, and so that's kind of the way
to think about it.
Speaker 1 (22:21):
Ye fair enough, you know, Steve, in the last minute
or two that we have here and you're gonna be
joining us for the twenty five Money Show Traders Expo
Las Vegas that's in February. I know markets can change
dramatically in an hour, a day, or a week, much
last a couple of months. I'm can you give viewers
a quick preview of the kinds of things you're going
to be talking about. There you talked a little bit
about the zero DT options. I'm just kind of curious
one of the things you might cover.
Speaker 2 (22:43):
I think we'll start to talk about that. I think
i'd like to talk about, you know, speculating in options
visa the hedging with options. I think we've you know,
the options markets developed. And I sound like a cranky
old man here, but options markets developed as a means
of risk transfer and hedging, not purely you know, yes,
you need speculators to make it go, but I think
(23:04):
we've kind of morphed into using options as speculative tools,
and I want to refocus people on the other characteristics
of options because I think we've we've fallen a little
too in love with the speculation and that falls into
you know, the general momentum trading. I think i'd also,
you know, depending on where we are at the time,
(23:26):
I always want to talk about the current volatility environment,
potentially talking about how correlation affects volatility. Indicies like the vicks,
which have a lot more to do with correlation and
dispersion of the S and P five hundred index, I
think than most people realize. Short answer is, if you
(23:47):
have a two stock index and both stocks move in
the same direction, that's full volatility. If you have a
two stock index and they move in opposite directions, that's
zero volatility. Obviously, it's a lot more subtle if you
tell you about a five hundred stock cap weighted index.
But there's the basic point. So so, and of course,
definitely you know how to sort of read things in
(24:07):
terms of you know, options, skews and options. You know,
to get a sense of the risk, the risk that
other people may or may not see in the market
and any given time, got it? Got it? Well?
Speaker 1 (24:18):
See if you clearly have a lot of insights to
offer and viewers, if you're watching this and you want
to learn more from Steve, he is going to be
speaking at the Money Show Traders Expo Las Vegas that's
February seventeenth to nineteenth at the Paris, Las Vegas Resort.
You find out more by clicking the link in the
video description below. Don't forget to like ris. If you
like this video, subscribe to our Money Show channel here
you'll get updates like these in between events. See again.
(24:39):
Thank you so much for joining the podcast and taking
some time out.
Speaker 2 (24:42):
Thank you so much for having me. Look forward to
seeing you in person in a couple of months.
Speaker 1 (24:45):
Perfect Take care, Take care. We'll have more interviews for
you every week, so I encourage you to subscribe to
the Money Master's podcast so you can stay up to
date with the insights from top money experts. You can
follow me on Twitter at real Mike Larson and follow
Money Show from Investing in Trading content on Twitter, Instagram,
and YouTube at Money Show. Thanks for listening, See you
(25:06):
next time.
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