Paul: a Perfect Example

Paul,


Pull up a chart of yesterday's S&P futures. Notice the perfect runup in the morning. As it rose, it triggered all the buy systems one-by-one. Then, a couple who exit based on a morning session flattened before lunch. Then, a larger pool who use stops, either a certain amount off the high, or below recent prices, got taken out after lunch. Then, towards the close, the bulk of the traders - who use the end of day combined with a stop based on their entry price - triggered each other in a neat cascade.


This is the cleanest illustration I have ever seen of how most short-term stock traders use a one-day wavelength for their systems. Volatility - which you measure the current move against - is pulled off the previous day's range, or off the opening range, or some combination of the highs and lows therein. I thought they would have the sense to stand aside, because Christmas Eve wasn't a normal day, but instead they just let the anomalously narrow range make the next day look abnormally trendy, and put them all in against a low-volume backdrop that revealed them in stark resolution.


By 1-day wavelength, I simply mean that if the market gets far enough from the previous day's close in either direction, they ratchet it out a notch, then if it drops back, they ratchet it back down into the range. It's almost binomial! The interesting thing, trading around them, is that they are usually right, meaning when they are long I cannot blindly sell short into them for a washout because, as often as not, they will get paid off. Moreover, this probability doesn't really turn until the exact moment they get washed out - meaning their systems are accurate on both sides. Understand what I mean?


A lot of insitituional orders are basically flexible as to the time of the day they are executed, but inelastic so far as their ability to postpone until tomorrow (unless a really big move adds or takes some away). And the institutional fillers get paid on, like, 50% of the amount they do better than the average price. So if prices have gone towards them, they may just fill the whole pile right before lunch whereas, if prices have moved away from them, they may postpone until after lunch, making it correct for a system to trade with the trend to fade their postponement.


But since there really isn't much structure around which to time acceleration and postpenenment inside a single day, shorter-frequency systems are much tougher. Plus, there are some other complications...


See what I'm saying?


eLROY

Where's a good place to pull up an S&P futures chart?

I tried Google, but I can't remember ever having found a decent place for charts on the web.


So I saved a bitmap of one of my screens, which I could email to you, or I could post a link to it if you can think of a good place to host it.


I have a couple web sites, but I don't usually screw with them, and I don't like hits.


leroy

> And the institutional fillers get paid on, like, 50% of the amount they do better than the average price.


Interesting. Can you list some of these institutional order fillers? How frequently do they collect their fee? Daily? Weekly? Monthly? I assume they don't rebate when they do worse.

It never occurred to me that they would get paid on anything apart from a per-order basis.


Here is one example of a filling service:


http://www.madoff.com/dis/display.asp?id=201&mode=1&home=1


Madoff uses this silly pitch to obtain visibility into client demand so they can lean on it all day!


Here are two links to just two firms that offer these sorts of services but, in reality, they probably all do:


http://www.elkinsmcsherry.com/


http://www.bear-hunter.com


You could even say a matching service like Posit creates the same effect, because there is an invisible leave-behind postponed over a series of batches, on one side or the other.


Just for your information, all the information on "best execution" in the entire investment universe is UTTER nonsense, and I am apparently the only expert. Seriously! Everything you will run across is myth and garbage, so ignore all of it. I repeat, do not pay any heed to anything you read anywhere about auction-market liquidity and market structure unless it was written (or at least confirmed as accurate) by me:)


Or, if it makes you happy, you can just choose to be wrong. I don't care. But you have been warned.


eLROY

Actually, I think the McSherry I was thinking of now runs SunGard Global.


But what just occurred to me is how NYSE specialists aren't allowed to chase or trend trade, but are only allowed to counter-trend trade, giving them an incentive to allow prices to overshoot, at the same time as handing the trend-trading off-floor to sharks at, like, ? Clearing (darn, I can't remember the name of the primary firm I'm thinking of!). There are also some redundancy-diffusion restrictions so far as, like, requiring floor-trader orders to originate upstairs.


So, probably the source of average-price guarantees, intraday av-price options, and so forth, is that a specialist firm can trend-trade if executing client orders from off floor. So he essentially uses the client orders to do what he is barred from doing, and then gets the money back in the form of a payout from the client. That may be what is going on in many instances.


But really, it's all just one form or another of the buy-the-pullback-and-save-money illusion.


eLROY

In summary, for every guy that is feeding an order out slowly - so as to avoid "market impact" - there is another guy buying frantically at-the-market - in exactly the size of the postponed order - to front-run the market-impact idiot.


If some people didn't believe in "market impact" then big orders would hit the market all at once, and it would be over - eliminating 99% of day-trading opportunities overnight.


It's just silly!


But as long as they keep postponing, we'll keep accelerating!


Like I said in an earlier post, the reason market orders work is only because, and so long as, some idiot is using a limit order. You figure out situations where too many people are inclined to use limits, you go to the market and front-run them, you win.


eLROY

Hi,


I've been reading the posts here for several weeks.


This looked like a good place to start my first post.


As a person who trades commodity's, on a SMALL basis, I can point you to several very good (free) chart sites.


1) This will give you end of day, and weekly info on all markets. As well as options, figured by strike price, puts and calls, and the settled price.


http://www.bohl.minot.com/


2) This will give you DELAYED daily quotes, by minute, you will need the symbol for the contract, the month to be traded, and the year. That list is at the top left. It's a different language than stocks. For example: the March contract for the S&P is sph2 (link). There is no contract for January or February.


http://partners.tradesignals.com/pricegroupcharts/chart/quickchart/index.php3?indicator=price&picWidth=650&xGap=4&type=chart&symbol=SPh2&time=daily&chartType=bar&ma=null&indicator1=null&indicator2=null&indicator3=null&x=25&y=9


3) This is the Chicago Mercantile Exchange (CME) lots of good stuff here, as well as charts. I think there is a quiz here as well. Worth the time to take it.


http://www.cme.com/


I am not a broker, having said that, you should know you can lose your home, dog, and the kids shoes trading commodities. Take the time to understand what you are trading, BEFORE you open an account. Oh yeah, you can not trade commodities in a stock account, you'll need a commodity account.


Steve B

Here is page on the latest mechnical S&P 500 futures trading program I have come across:


http://iasg.pertrac2000.com/SnapshotPT.asp?ID=497


The S&P's have chopped up a lot since 9/11, but apparently he is still making money!


By the way, for a good measure of how choppy vs, trendy the stock market is intraday, try...


...on second thought, I'll not post that link today:)


eLROY

Note he has one year of performance with one account at his minimum requirement of $1 million. With notional funding it could be a lot less money.


Tell me this is a bad example or tell me which one of Jim Feist's guys is hitting 65%.

I was a member of the CME,NYMEX,NYFE,and CSCE.The trading floors are a different place than you make them out to be.There is a lot of stealing against orders for one thing.Secondly many traders trade by the seats of their pants.It is my experience that "morons"can do very well as day traders because they are sensitive to the emotions occuring in the ring and can "scalp"

effectively.They know nothing of fundamentals and don't care.I am an options trader.I take fault with your belief in trends.Most but not all trend folowers get stopped out.When I trade I only put on a position if their are 4 ways to win and one way to lose.Yes thats right...I put on options positions where I can win many ways regardless if the market goes up or down Anything else is gambling.

First, I really don't care if markets "are" trendy or choppy, and I certainly don't "believe" they are one way or the other. It is quite easy to confirm whether one or the other has been true by 1) eyeball observation, 2) computer analysis, or 3) a quick examination of the published returns to representative philosophies.


Moreover, they are only choppy precisely to the extent to which people have evolved around their being trendy. To say they "are" trendy would be like saying a certain fishery has a lot of fish in it. What trend trading really involves is clocking the changing bankrolls of people like you who do blindly "believe" - and aren't likely to change your minds!


So far as scalping and leaning in the pit, it's mostly local-on-local lately, but I would refer you to this post:


http://www.twoplustwo.com/cgi-bin/newforums/genpok.pl/read/29134


One thing that does still work, however, is locals running the market one way or the other in a pre-lunch vacuum to predictably stop the trend day-traders in and out. What you should ask yourself, as a floor operator catching an off-floor trend trader coming and going, is how can I do this each day, and yet either A) they still have money, or B) new ones keep popping up in exactly the same place? Chances are, if you keep killing long-necked giraffe and more only show up to take their place, somewhere there are some pretty tall trees.


So far as options, well, here's an essay I wrote a while back about the game as it stands today:


I've been hearing this recent story about an options firm down a zillion dollars stuck long volatility. If I understand it right, they went out and bought up all the rights to lean on people, at prices they believed would be a bargain to anyone stuck for someone to lean on, in a pinch, in a potentially gappy environment. They got unlucky, and lost -- or did they? Could this strategy possibly have made money in the long run, or was it doomed all along?


It only stands to reason that the more volatility people have available to sell, either the less distress there actually is, the greater the perceived ability to outrun friction and manufacture replicating portfolios, or the greater the ability to simply swallow such volatility as may come like a man, with an internal cushion. Moreover, some widespread, redundant, and therefore self-defeating misperception of the ability to dynamically hedge seems unlikely here, as this large, central, low-friction operator would have inevitably fallen on the other side of such a trade.


So, the real question is not why did this options firm find itself on this bad side as opposed to that bad side but, rather, why was it inevitable that they find themselves on the bad side of the trade, whatever side turned out to be bad? And remember, we're not talking about you and me, we're talking about people who are more fluent at risk management than a cow is at eating grass. The real question is, what sort of a system are we dealing with that creates this adverse selection, where the statistical tipoff to which is the wrong side comes in the form of where you are able to enjoy the largest volume of apparent "bargains" the fastest?


The sort of system than might create this is one across which the perception of what is a "bargain" and what is not has become relatively uniform -- a system characterized by substantial low-friction cross-pollenation, dissipation, and dispersion of information, strategy, cultural evolution, liquidity, universal access to decks of orders, you-name-it, across participants. As such, with the original asymmetries that yielded unilaterally and bilaterally profitable options transactions gone -- asymmetric volatility models, asymmetric friction, asymmetric utility for payoff patterns, etc. -- transactions can't any longer reflect asymmetric external conditions meeting, or even asymmetric theories meeting, but more likely actual conditions meeting theories.


In other words, why would one party be a buyer and another a seller of an option at the same price, where those parties exhibit the same general beliefs and conditions or, even worse, where the chief possible difference is the larger ability to hedge and manage risk of one party who is nevertheless, for some bizarre reason, actually buying that ability from somebody else who somehow has this ability in even greater abundance? Whom did they think could be taking the other side that that party coulf possibly be "wrong"? I mean, the counter-party defined the "right" price in this situation. Did Casio sell a batch of bad calculators in the 1970's, could that explain the presence of a sucker at the table who is not you?


Weren't the "inflated" put prices prior to October 1987 in fact evidence not of any idea at all, but rather of people who had, in effect, already sold, and just hadn't been priced in yet? Could anything apart from an actual lack of underlying liquidity-related distress cause a weighting of realizable bargains in those transactions going long volatility? Were there truly yet-undiscovered distress landmines lying in wait, would not the "bargains" have been inevitably weighted in those transactions selling hedging and volatility absorption, not knowing that the sheer numbers of transactions themselves, the success of the strategy, rendered the strategy invalid?


No, the only way large numbers of transactions can take place at a "bargain," when the vast majority of participants are in agreement as to what a bargain is, is if they are wrong. The price can only move to the bargain point despite having to chew through the countervailing orders -- soon to be washed out -- of those who believe it is a bargain, and where such ideas should presumably even by held by the individual participants whose conditions collectively constitute the underlying conditions their orders are meant to reflect, proving their ideas about underlying conditions are wrong. Where some supply is withheld due to a belief that Price X is cheap, or where some demand is created simply among middlemen reflecting buyers who are also reflecting rather than selling, simply as a result of the belief that Price X is cheap (though the underlying buyers being reflected presumably think it's cheap too and yet for some reaosn the fills are there for the taking), and yet supply and demand match at Price X, the correct price is inevitably something leds than Price X.


Moreover, when the actual supply of liquidity and volatility absorbtion is indeed greater than the demand at Price X (which price is only propped up temporarily by ideas), or whatever the product, the buyer of last resort is nearly always the biggest and wealthiest, the very epicenter of the bad idea, whether Long Term Capital buying bonds in 1998, whomever the biggest portfolio-insurer was postponing short-futures updates in the S&P 1987 awaitng fair premium, or the California government selling electricity in 2001. So, as the friction in the financial system goes down, and the symmetry goes up, we can expect the biggest players -- or at least the ones who stick their necks out the furthest on the basis of some silly "pricing engine" -- to get picked off and hammered on a regular basis.


The moral of the story is that you can pass around losses, and risks of losses, all day, until the person who owns them is the one who is best able to absorb them or to prove in advance they don't exist. But when the inventories of risks start to pile up among middlemen, based on theories of actual counter-parties, it is generally proof that the price is wrong and someone is going to get blown out. Anybody with a redundant idea about a counter-party becomes the counterparty himself, able or not and, with the Brooklyn Bridge for sale, sellers of real bridges at real prices are likley to see slow business, relatively speaking.


Or something...


leroy

You analyze way to much.Here is an example of a trade that occured in approx 1987.These trades happen all the time. Bot 500 march 10 cent calls

sold 1000 march 12 cent calls ,bot 500 march 14 cent calls.Started doing them at 3 ticks(approx 33 dollars)and paid up to 7 ticks.It was the sugar market and these are simple butterflies.My risk to reward was over 40 to one on average.As a floor trader I NEVER cared about volatility or fundamentals when these opportunities presented them.

Now here is a trade I did within the last 5 months in bond options.Again,I don't know crap

about all the nonsense you concern yourself with.

If you spent half as much time looking for good opportunities in the options market as you did in reading all the garbage out there you might make a few extra bucks.BTW I am no longer a mamber of any exchange and have been trading from home now for over 10 years.Back to the trade.

Bond options with 10 weeks to go..hi volatility.

Buy 50 dec 110 calls

sell 150 112 calls

buy 50 113 calls...eacc 1/3/1 done for 15 ticks credit or a total of 11,700. credit.Bonds at approx 108 and 1/2 when done

If bonds go down I collect the credit.One way to win.If bonds go up slowly I collect credit plus

whatever I can sell the 110 calls for.Way 2 to win.

If bonds go over 110...incredible.

If bonds go to 112 ...homerun make near a million.

Over 113 and I am hurting.That would have equated

to a yiels well below 4.6 % on the thirty year

bond.So go ahead and read all that nonsense while I trade away.

What the heck is that!? Do you really call that a strategy??


I'm sorry if I insulted you, but I'm still curious as to what you are defining as an "opportunity" here - the simple fact that 100's, 112's, and 113's are available?


There is no question that the "opportunity" to buy/sell/buy 1/3/1 "happens all the time." But you sold 50 bonds for a small move (and got a big one), so what? I sold the bonds 3 points higher on a counter-trend trade, and EVERY trend trader in the world sold the bonds where you were selling them, or at least right after!


And don't give us this 40-to-1 risk-to-reward crap, there is hardly a visitor to this sight who doesn't understand skewness or other complex distributions! You think you can pull some sleight-of-hand by befuddling us with the permutations?


And apparently you "don't know crap." Your reward was capped in the bonds, your risk was infinite. I don't know how you figure infinity into an average.


You should pay closer attention to your broker because the selling point on the butterfly - aka the "commission spread" - is that the client's risk is capped - exposing the broker to commission only - and the ways to win are so numerous the client is left just saying "hmmm - that sounds like a profit situation."


So tell us, how did you do it, what was so special you noticed in 1987 and 2001? What signals tell you that conditions are right to execute a 1-3-1 (rather than a butterfly)? Or, let's break it up into a bull, a bear, and 50 naked, and tell us why you did the 50 naked!?


What was so simple about your asymmetric opinions regarding the distribution at expiration arbing between, on the one-hand, the full-contract trend traders and, on the other hand, the math/volatility traders? Was it just for the credit? Did you fool yourself? Or are you just a counter-trend trader at heart?


Thanks,


leroy

You still don't get it.Regarding the sugar trade,I was on the floor so commissions were negligible.But at 3 to 5 ticks even PhilBro did

100s.Who do you think sold them? One of the big computer trading outfits.This was a simple butterfly there is no complexity here.No permutations.A SIMPLE BUTTERFLY!!!!

Regarding the bonds, the 1/3/1 for big credits when

your negative window is way out of the money RARELY occurs.This was the rally after the 9/11

incident.Remember there were only 10 weeks to go.

Regarding selling the bonds at the 110 level if that is where you sold them the trend as you like to call it was up..not down.also you may have been

caught in the move prompted by the fed announcing the retirement of the 30 year bond.They traded over 112.My option position had turned from a delta short to a delta long position.If you were short you may have been squeezed.I have made a living since 1978 on and off the floor...keep it simple.

As I said, I sold the bond short at the high on a counter-trend - but details aren't important to you. Trend traders don't "get caught." Moreover, I can only assume you are used to getting credit simply for proving you can recite what the bond did last month! Good boy (everyone claps).


What you are saying is that you made a market in commodity options in the 1970's - when a deaf goat could have made money in the pit (and Hillary Clinton turned $1,000 into $100,000) - and then you got lucky (ish) again in 2001.


There is no "keep it simple." There is nothing inherently profitable about writing a butterfly!


You have still not given any hint that you have a brain, and that you know "when" to write a butterfly. There are only about a million people "keeping it simple" in the options market on a given day.


You said,


"Regarding the bonds, the 1/3/1 for big credits when your negative window is way out of the money RARELY occurs."


I can see how you might think something is profitable, if it happens SO rarely that you don't actually have a statistical sample for your strategy.


You still have not given a hint of a useful strategy in options, and I would be surprised and amused if you actually had one!


Sure, you sell a butterfly when it's mis-priced. That's like saying "buy low, sell high." Keep it simple. But that's not even what you said. All you said was "buy, sell." And of course, one filters out and isolates mispricings by hedging. But you have spoken only of hedging as creating the magic in and of itself, in the absence of mis-pricing!


You bought a lot of different memberships for somebody who found something that works. Sounds more like...


well, I won't go into that:)


BTW, where is Phibro - or Enron for that matter - today? Keeping it simple, I imagine. The computer outfits, like O'Connor, did well in the 1980's, but there is certainly nothing simple about general autoregressive conditional heteroscedasticity. It's all history, curious relics, and you are an intesting tale-teller - a historian but not a player.


But I have a feeling you just like to say "keep it simple" to egg people on and pretend like you have some magic that no one else gets. Truth is, in the year 2002, you have no magic, and not a lot of luck. Or prove me wrong, we're waiting to hear your secrets!


"I have made a living on and off floor since 1978 blah blah blah..." What are you, a convention speaker? $500 seminars? Is that your gig? You still have a chance to get real, and you can start by explaining the reasoning behind your sale of 50 naked bond calls at 108 1/2! Heck, make one up!


You have fun!


leroy

Whatever is right..you don'thave a clue.First of all when I was on CME in the late 70s and early 80s I traded spreads in the currencies. My seat was a rental.I moved to N.Y.I bought a seat on CSCE and the NYMEX.The same trading floor genius.

COMEX was also located there and so was the NYFE

and the Cotton Exchange.Regarding the computer trading firms on the floor CRT was the big one.

Totally clueless like yourself.You want secrets..HA!You call me a story teller.How much are you willing to bet? You use a lot of big words.

I will say it again there is no holy grail.I have been making a living since 1978 trading.For

2 years I was off the floor in the mid 80s as the proprietary silver trader for a large brokerage house.My guess is you are a hope trader.You hope you will be around tomorrow.I have made it for the long haul.BTW you obviously don't understand what happens to your order when it hits the floor.

That was evident from that article you directed me too.So I will tell you.You place an order to sell 100 at 98.The market is 98 bid at 100.The broker that has your order shows it to his friend.

His friend offers at 100 also.If the friend gets taken he buys at 100 from the broker.If not he buys what he sold at 99 or 98.This goes on all day long.Try and get a real world education.all those books and articles you read have you confused.

First, you have a lots of funny sayings - like "you are a hope trader... blah blah blah" - but nothing material to say about trading strategy.


Second, I could accept the theory that you might be able to make a profit using on-floor shenanigans/advantage - except you couldn't even describe their mechanics accurately! You said that, if he isn't filled, "he buys what he sold at 99 or 98." You must be used to people who don't even care about details but will eat up anything you say!


Third, I actually have a post on some of the problems of option-order execution:


http://www.twoplustwo.com/cgi-bin/newforums/stocks.pl/read/1492


I know what goes on at The Chop House, and I never trade illiquid future options from off floor. You are the one claiming to be doing it and making a profit. So are you eating the off-floor guy's lunch from on the floor, or are you off-floor and not getting your lunch eaten?


Fourth, so far as "betting" whether or not you are for real, I have no interest in wasting my time betting against small-wallet loudmouths who never pay. The cost to you of your boast is zero. Your offer to enter into a bet is made 100% on your knowledge that you are impossible to prove, nail down, collect from, etc.


Fifth, again I ask you, why did you sell 50 naked calls when the bond was at 108 1/2? You have already said, well, 4.7% or something seemed too low, or volatility was "high." Is that the best you can do? Nice strategy. That would put you short 10 months out of every up year, and entirely through every up trend.


Sixth, some people post their actual audited perfomances on the web. Other people post their trading ideas on the web. All you post is the year you were a member of the CSCE! Like I care! I have met a few ex-NY-pit futures traders, and they have all split because the profits in the pit dried up.


So you can't go back to the floor. What are you going to do?


eLROY


P.S. You never said a first time "there is no holy grail." I said it in my post in the other forum where I directed you, and that is why it popped into your head.

Dr. Bill -- I would like to understand your example, but I'm having trouble with some of the unfamiliar terms. Here's what it sounds like to me, but please correct me where I'm wrong:


These are options on the 30 year treasury?


All of these options have the same expiration (in December)?


Based on your numbers, it sounds like one tick is 1/64th of $1000.


By buying 1 110 call, 1 113 call and selling 3 112 calls, your net was 15 ticks? This is about $234? Before or after commission? If before commission, how much is the commission?


Also, if I understand correctly, your maximum possible loss, although huge, is not infinite because even if interest rates go to 0, the (maximum) price of the 30-year treasury will be the sum of the (undiscounted) coupons and principal.

These are options on the 30 year treasury.They are extremely liquid.The typical bid ask is one or two ticks.One tick =$15.625.There is an expiration every month.I pay a commission of $4.00

per side.The credit I listed was after commission and you were correct approx.$234.00.you were also correct about the maximum loss.The basis of the trade was a number of factors.There was panic in the market and I received a good credit for a trade which had a chance to expire in my window.

Secondly ,if volatility came in the trade would make money.If rates went up but vol moved out I would make money.If rates moved up I would make money.I thought I was taking a "reasonable" risk.

My present position is the following in the January 30 year options and were done on 12/20/01

bot 3 january 98 puts sold 6 january 97 puts.

I did each 1/2 for 12 credit.I planned on scaling up as the market broke but after I did my first

"package" it was over.This trade settled at 5 credit yesterday and it is still a sale there.

Just what I thought..all talk.Here is the $5000.00

challenge.I will provide a copy of my latest option trades listed in the thread below.I will prove my former memberships in three exchanges.I will provide copies of the Wall Street Journal where I am quoted.Keep hoping. I will not waste my time on a wanna be.

It is nowhere clear how you can make near a million.


That would be a neat trick!


leroy

You idea makes sense, that a future shouldn't rise to more than the total value of the coupons on the bond theoretically contracted to be delivered. But it just isn't the real world.


In the real world, things are cash settled, there is no perefct aribitrage, people can get squeezed, some idiot can pay whatever he wants, weird unprecedented things can and do happen!


Like with the 1987 Crash, it is the assumption that something can't happen which causes it to happen. In the world of derivatives, someone has to back your promise to deliver, and you will be hard pressed to find a person still in business who will entertain capped-price assumptions.


leroy

According to your post to Paul - who probably actually is a "Dr." of something or other - you are not trading in 250 contracts but, rather, 9 contracts.


Which would explain the proportionaility of your $5,000.00 piker's bet.


leroy

Yes or no? $10,000 $20,000.It is a lock for me.Whatever you want to bet.BTW I am not a DR. and never said I was.So what

Where is your cash deposit, Dr. Bill?


And what claim do you wish to prove?


Certainly not that you are "making a living" trading bond options.


Not unless you are living in a cardboard box!


leroy

The correct figure for the bond trade was 100k.I was thinking about the sugar trade.

Here is the bet.

I will put up 50k with Dave Skalansky

You put up 50k with same.

I will show him my trading statements for last

15 years.The option profits are from many exchanges.I occaisonally trade futures as well.

Normally I am a spreader but once in a while I will scalp the market.The vast majority of profits

are from option trading.Yes or no MR.Wannaabee?

These are Feb options

They expire jan 25

Listen, I wasn't born yesterday! A guy like me is all too easy a mark for a bet with a liar!


I always catch liars, and they always say "want to bet" and I always say "yes!"


Or at least I used to. But, over the years, I never once collected. Then the trick occurred to me - it was not I, but rather the liar who proposed the bet, and made me feel like I had proposed it.


There are basically two possibilities,


1) that you are George Soros posting incognito, or


2) that I will never collect, somewhere you will worm out of it.


So, seeing as it's a lose-lose situation for me, the dumbest thing I could possibly do would be to post a dime. If I win, all I get is to hear how you said a million, oh, but you really meant $100,000.00. Sklansky has not agreed to mediate this and, more often than not, the money-holder gets played for a sucker by the liar somehow too. In case you haven't noticed, there's a side-bet going on here, my bet that I would never collect, and the only way for me to win it is to never post!


"Clear a million!" HA! (To quote you.)


You thought you could make a million in 2001, but then you realized you had it mixed up with the only other trade you had put on up until that point, in 1987. You were thinking "112, 110, 113" - bond handles - but then you were thinking "a million dollars in 1987 in sugar?" Get real!


These are not the thought processes of a serious trader, or someone who trades for a living, or, more importantly, of someone who expects to be taken at his word by anyone apart from a sucker.


Notice how I, a man of honor, DO NOT PLAY THESE GAMES. I have not once accepted your bet, because I would pay off! I expect to be taken seriously.


eLROY

You don't even know your own position?


This is NOT a casual mistake!


Good grief, do you have William's Syndrome or something?


I caught you lying, you proposed a bet, then you admitted you are a liar, and you still haven't learned how to tell the truth on the Internet!


Geez, I would really love to discuss trading here, but we're still trying to get around the nonsense with you! Just be honest, for once, and I'll be your best friend! Nobody else pays half the attention to my posts that you do!


So let's talk about trading, and stick with the facts from here on out, and you'll be the hero of the forum!


Which is what you wanted from the start anyway...


eLROY

Thanks for the info, Dr. Bill. You wrote:


> If bonds go to 112 ...homerun make near a million


Based on the values you reported, it sounds like you make $111,700, not $1 million if the 30 year bond is at 112 when the options expire. Is that right? ... Each dec 110 call would be worth 2 points ($2000), while the 112s and 113s expire worthless, so your 50 110s are worth $100,000 and you add your $11,700 credit to get your total profit.


You said that you did this trade within the last five months ... was this in August?


You also reported that the 30 year bond was about 108 1/2. Is the coupon 6%? Assuming it is, it sounds like the yield was about 5.42%. But then you report a price of 113 corresponding to a yield of about 4.6%. Doesn't the 30 year have a duration around 15? If I've got all this correct, I would think 113 would correspond to a yield of about 5.14% rather than 4.6%. If so, you would be crushed if the yield fell to 4.6% ... the 30 year would be over $122. So maybe I have the coupon and the yield at the time you traded wrong. Let me know. Thanks!

Then you suggest a reasonable third party.I actually trade for a living and have for many years.You must get paid for posting because thats what you seem to do all day.You come up with what you feel are the conditions which would be acceptable and the bet is on.Either I am a liar or George Soros?no wonder you can't trade.Why don't you make better use of your time and look for trades during the day.Get your nose out of your books.

One more question, Dr. Bill. Are these options American or European?

In this case, there isn't much difference because the 30 year can reach an astronomical 280 at 0% yield (assuming 6% coupons). But with shorter maturities, whether justified or not, a lot of fixed income firms assume that they have limited exposure on their naked shorts. If you think they're wrong, can you think of a way to exploit their mistake?

Hi Paul,

The yield I quoted should have been approx.5.6%.I feel like a moron but I am extremely busy during the day.At present I have positions in 3 markets and a rather large one on the NYFE.I may wait to respond till the end of day where I can pay closer attention to my writing.The point is to "pick" your spots.I can't quantify this statement as eLROY would demand.It is a combination of using your head and your instincts..

For instance I went short 1 S&P yesterday at 1159.30. I bought it back at 1158.30 because it

seemed to be "acting good".I will be looking for a place to sell it today or Monday.I am not saying there is no room for mathematically verified trades.I did a spread between the Dmark and Swiss

which NEVER lost money for over 10 years until they converted to the Euro..and I took a shellacking in the process.Anyway good luck in your trading.

It is probably a negligible risk.


And the options are probably priced correctly.


But, if they got near the ceiling, and I swung a big enough line, I might want to see if I couldn't trigger some kind of a late squeeze or something. If people sniff out that such a snafu might be possible, it generally becomes self perpetuating, as everyone flattens up, and somebody gets left without a chair when the music stops. And not enough people have the authority to commit the capital on a moment's notice to create a competing auction to absorb the naked positions. Remember the David Askin liquidation?


At the very least, I would want to not risk being in the same boat as too many other people using some kind of cap assumption. It's only safe if you're all alone.


Over Christmas, I was reminiscing - with a guy who used to do swaps and repo's and that kind of thing on the Prebon money desk - about how the Fed didn't used to make an overt statement about the Fed Funds target, rather you had to deduce any policy changes by seeing where they intervened or not during the day. We recalled several times when the Fed Funds traded at, like 47% or 51% or something during the day. It's not negative percent but, at the same time, it is evidence that buy and sell orders are not the product of flexible individual decisions, but rather pop out of huge, inflexible machines.


A machine is apt to pay any price, ultimately following the normal distribution.


eLROY

A very good common sense approach.Stock brokers tell you not to short stocks because you have unlimited risk vs limited gains. How foolish.

... I can't believe how well you've taken eLROY's badgering.


Contrary to what he implies, there's no need to feel like a moron for getting some figures wrong in a quick note to this forum, especially if you're willing to go to the trouble of setting things straight, as you've been doing.


I'm still worried that the numbers on this trade don't look right. The one year volatility of the 30-year must be greater than 10% (I'm guessing it's around 15%), so the one quarter volatility must be greater than 5%. This means that, assuming you made your trade at least three months before expiration, 113 is less than one standard deviation away. Assuming a gaussian random walk (which is conservative, since the real distribution has long tails), I estimate that the expected return on your position is below -10 ticks (including your 15 tick credit) ... perhaps well below.

I did the trade with less than 10 weeks left.

Long and wrong! Oh but you probably bought the uptrend into January of 2000.Still waiting to get even?

If you are asking whether you can exercise early

or be assigned early the answer is yes.

Dr. Bill,


I called the high on the morning of Thursday, March 30, 2000 - 4 days off the Nasdaq 100 high, and the week before the meltdown began. How did I do it?


During the bull market, I became an expert on the psychology of pullbacks. Specifically, beginning during what I call "The '96 Payroll-Number Era" (beginning the first Friday in March of 1996, and climacing on July 16, 1996), I began toying with a strategy that, more or less, went


1) buy first pull back,

2) buy second pullback,

3) scalp or sit out third pullback,

4) sell short fourth pullback,

5) keep selling short pullbacks until you get a washout, and

6) start buying pullbacks again.


Looking at how the S&P's reacted to the stunning job growth - in a period when interest-rate action from the 1980's was still remembered clearly and the S&P's tracked the bond all day - you will see that following the first Friday of each month starting in March of 1996, the futures behaved perfectly so as to frustrate anyone who had "learned" how the Non-Farm Payrolls event resolved itself in the previous month.


(The system traders in the bond were also massaged into a 5-day cycle which fed back into this Friday-report phenomenon. To see what I mean, run an algorithm over the last 20 years that buys or sells bonds when the 5-day close-to-close rate of change is greater than the 10-plus-1-day average 1-day close-to-close rate of change times 2.6.)


In April and May of 1987, people had also clearly learned to buy the pullback. And in June and July of 1987 the pullbacks failed utterly. As such, it was a fair bet that people were loading up into the September 1987 pullbacks - meaning there was enough underlying selling going on for there to be pullbacks even though they were camouflaged by short-term buying.


Then when, in the beginning of October, 1987, the market failed right before actually paying off those who had bought the pullback - failed at the moment they actually tried to take their profits - and instead dipped back down for a third helping of buyers - you knew it was the doom scenario. (Visit channelingstocks.com for an illustrative example of the idiocy.)


So, I saw the same chart thing setting up in the Spring of 2000. If they hadn't learned to buy the pullback before, they certainly learned to buy it in the the tax-loss and other selling during January 2000. The big-washout buyers had gotten paid in The '97 Needle and the '98 Washout. In '99, they had waited all Fall for a real buying opportunity to lock in, but there were too many chasing it for it to happen.


So it set up perfectly, just like 1987. On 3/16 and 3/21 2000, the fast-money/Yahoo crowd were clearly buying the Nasdaq pullbacks for a new high. And yet is was pulling back anyway. Then, it crept up towards a new high, but instead of making one, it pulled back for a third dip of buyers. How could it still have an appetite for more unless there was camouflaged selling? So on that morning I called short, though unfortunately, I still saw the market in S&P-futures terms, and the idea of selling the Nasdaq 100's never occurred to me!?


Then the first nasty day came the next week, when the people who had taken the third dip got overwhelmed and washed out. But at the day's low, I called the reverse, because I knew - having "learned" from 1997 - this is where the second wave of longer-term suckers would dig really deep into their pocketbooks and make a final stand. It reversed off the dizzying lows famously.


But I predicted an even worse washout as soon as this crowd tried to sell back down to the sleeping level - or the moment the market crept towards their margins, coming soon and time-structured around the days of the week, regular-way settlement, or whatever. All the buyers were spent for the time being. Then the washout came and, at the close on Doom Friday, when everybody was scared, I predicted Monday would be a non-event.


Just in time on Sunday, I came across a San Francisco Examiner article that confirmed my entire hypothesis:


http://www.sfgate.com/cgi-bin/article.cgi?file=/examiner/archive/2000/04/16/EDITORIAL1.dtl


It wasn't until maybe May 2000 that I got REALLY long-term bearish. And it wasn't until I really sat down face-to-face with people on Wall Street and Sand Hill Road, and really got inside their heads about a year ago - in the Nasdaq 2850 area, that I stretched my expectations the whole way down to Nasdaq 900 or something (I don't remember exactly).


Of course, I did call the low after 9/11 to the day, just like I called the '98 low to the day and on that day named the ten highest-flying blue chips of subsequent period (not Nasdaq yet-unknowns) almost to the stock! I also called the early '96 low to the day, and the '97 Needle low to the half hour.


Am I a billionaire? Not a chance. There are a lot of ways for a someone to screw up, even if he can predict the stock market. You might even say "especially if he can predict the stock market." Anyway, you really should read that article, so I'll post it again, and it is also a lot of fun to go back and read 1987 papers, which I have done quite a bit of.


http://www.sfgate.com/cgi-bin/article.cgi?file=/examiner/archive/2000/04/16/EDITORIAL1.dtl


eLROY

If you have a knack for picking lows in the stock market or in individual stocks you should be

doing "fences" in the options.The stock market is

the only(except on rare occaisons) that pays you to go long.I would love to hear an explanation for the skew in the stock market and stock options if you have one.I am referring to the fact that puts that are equidistant from the money as the same calls trade at a huge premium.

I have never heard a satisfactory answer for this.

There are two reasons why equi-distant puts and calls trade at different prices. One is known as put-call parity, and is based on interest rates, and the other is an asymmetry based on the nature of an investment. I mention the first just to make sure people know what the heck we are talking about when we say equi-distant!


Futures trade at a premium to cash, because you can construct a synthetic risk-free bond by buying the cash today, and locking in a future sale at a future price by selling the future today. If this were not so, you could sell short stock, earn interest on the proceeds of the short sale, and buy a future to ensure you then bought the stock back at the same price.


You can construct a synthetic buy-side futures contract by buying a call and writing a put. If it trades lower, they will certainly exercise their put against you and, if it trades higher, you will certainly exercise your call! Either way, you buy it.


Therefore, to compensate your free money if you short the stock, earn interest on the proceeds, and buy the stock back at the same price using a synthetic future, you must pay more to buy the call, and get less to sell the put. So far as I can tell - and I'm pretty weak in the math department - the puts and calls trade as if they are equi-distant from the current price expanded by the risk-free interest rate to the expiration date.


Now why, rather than stock-index options reflecting a symmetric distribution, do puts seem to imply fat tails on the downside? You have to remember what an option is, it's a right to lean on someone. The ability to absorb leaning and risk - to be a shoulder to someone else's uncertainty - is a function of economic wealth. As the stock market rises, the systematic ability to absorb risk rises.


The ability to accept price X for an option is not a function of the price of the stock. Rather, both the ability to take on a short option, and the ability to carry a long stock, are a function of liquidity in the economy. People who can afford to buy stock can afford to sell calls. People who cannot afford to buy stock cannot afford to sell puts.


So the level of the stock market is a measurement of the ability of the economy to absorb uncertainty. People think volatility means rapid movement of the indexes in either direction when, in reality, it is only movement to the downside that constitutes volatility. Movement to the upside is a measure of the absence of volatility. The more volatile stocks are going to be, the less people can afford to pay for them.


It's really so simple, and yet it is very hard to explain or understand, and the error is widespread in both academia and on The Street. You go to Emanuel Derman's derivatives section on the Goldman Sachs web-site, and you see he has some crazy, ridiculous scheme for hedging volatility - so as to create replicating portfolios to manfiatucre and sell volatility options. He goes long every put and call up and down the strike-spectrum or something, so that he has no delta or gamma, only vega.


In reality, as volatility rises, the stock market falls, and you can hedge volatility almost perfectly by buying deep-out-of-the-money puts. This is demonstrated by looking at any chart, I don't know why people second-guess their own eyes! The VIX doesn't rise as prices move fast, and fall as prices slow, the VIX rises as prices fall, and falls as prices rise! Prices fall because of uncertainty! Anybody who buys a deep call to hedge an increase in uncertainty - assuming if the stock jumps volatility has risen - is an idiot!


Have you ever heard anybody say "I don't know where the economy will be a year from now, so, hmmm, I guess I'll pay 100 times earnings as soon as I'll pay zero?" No, that is a false symmetry! When you have no idea how fast the economy will grow, it is not equally likely to grow at 10% and -10%. Economic prosperity is a product of information, which leads to accurate planning, minimizes misspent money, minimizes the amount of money wasted on insurance, on airport screening, allocates capital to the most profitable uses!


Even Black Scholes is wrong, the cost of an option is nothing more than the cost of hedging. Meaning, options transactions arise from asymmetric hedging costs, not asymmetric volatility expectations. A covered call writer sells cheapest because he incurs no hedging liability, followed by a floor operator surrounded by clerks who can get in and out cheaply all day, followed by an off-floor writer who can only buy and sell in awkward clumps.


Suppose you hedged a call by buying every time it crossed above the strike, and selling every time it crossed below. Okay, let's say a print at five cents above, vs. five cents below is your tirgger. If it is now currently $1.00 above the strike (and you are long the whole offsetting position), what is the chances it will reach the strike - forcing you to lose 5 cents at least once before expiration - and how soon is it likley to make first-cross - meaning how many times will you expect to lose 10 cents on additional crossings before expiration?


The price you charge to "manufacture" the call is the sum of the number of times you expect to lose 10 cents, buying above and selling below the strike price (assuming you choose 5 cents). As it nears the strike price from above, the chances you will spend 10 cents at least once rises. One way you can hedge this is by selling some stock right away, so that you make a profit as the chances you will lose 10 cents at least once rises.


So you suppose you are short a call you wish to hedge, and you are a dollar below the strike price. You are long no stock. The chances you will have to buy some at the strike, and eat 5 cents slippage, are almost zero. But, as the price rises, and the chances it will cross the strike at least once rise, your liability rises. So you buy some tiny amount of stock that will exactly offset this growing liability.


At the moment it crosses the strike, you theoretically buy the whole offsetting position. But at this moment when it is sitting right at the strike is when your liability is highest, becasue it could just cross and cross, and force you to buy and sell and buy and sell, right up to expiration. As it moves away from the strike to the up side, this risk, this liability, goes down.


So you sell short some stock which you will lose money in at exactly the rate your liability declines. But since you are long a whole position, you sell short against that, and simply carry a smaller position. Eventually, you get so high above the strike price, and expiration is so near, that a further move higher is not likely to decrease your chances of a crossing-slippage anymore, so you unwind your last short, and are long the full offsetting position.


So, your strike-price-crossing transaction hedges the liability of the option payout. And your gradual transactions hedge the costs of your crossing transaction slippage. Next, you need to adjust your gradual transactions so that they hegde their own costs slightly!


So, ultimately, the cost of manufactuting a call is a function of the bid-ask spread - meaning your expected slippage when hedging. And the width of the bid-ask is a fucntion of how far people are willing to stick their necks out with limit orders, given volatility and gaps in price movement! So, whereas Black Scholes is contingent on there being no gaps in price movement, the cost of an option arises specifically becasue there ARE gaps in price movement!! Otherwise, hedging would be costless, you would lose an infinitesimal amount at every strike-price crossing to buy and sell.


As such, Black Scholes is wrong but, like so many chance evolutionary traits, it has survived simply because it produces a dynamic hedge ratio which happens to mimic hedging the cost of hedging (when you plug in the right inputs)! But when you look at the math which is incorrect and think it means something, and forget what an option really is, is when you get led astray. So you ask silly questions like why do puts imply an abnormal distribution, when the underlying premise is wrong.


Prices are always right, as they say, and the first place to look at if your math says they are wrong is at your assumptions. Or, you can just completely blow out like the Nobel-Prize-winning mathematicians at Long-Term Capital! Lucky for me, I can't do math, so I'm immune to many of these popular intellectual viruses!


eLROY

I will have to consider what you wrote for a while but consider the following.If you buy a stock and immediately sell an out of the money call on that stock it is the EXACT same trade as

selling a put.Since a call can be converted to a put and likewise a call=a put.Or, C-P=L.

Regarding LTCM,they are morons but rich morons and people can't wait to give them money.The trade they convinced themselves was gold, buying corporates and selling treasuries is a trade for a fool.I would never go that way.I would only go the other way at a pre-determined level.The name of the game is not making money every day but staying in the game over the long run.

Back to your essay.I will look at it over the weekend but I have a feeling that you have a tendency to make things more complicated than they are.