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By the time this newsletter is distributed, I’ll be in Washington, DC, visiting some subscribers and doing some business. But I am also visiting old friends, including the guy who interviewed me at Botta Trading, LLC, back in 1999 in San Francisco. He is a financial advisor in the DC area now, after having been an options market maker for many years. I think he likes the change of pace. We’re going to tell some old stories and have a few laughs. By the way, he is a big fan of my novel All the Evil of This World, which is about trading options at that particular point in history.

The day that I started at Botta, one of their traders was quitting. I bumped into him in the office. “Good luck,” he said. His chief complaint was that options were now multiple-listed, i.e., listed on multiple exchanges, and the competition had compressed bid-offer spreads, as expected. His view was that the edge was disappearing, and he’d better get out while the getting was good. 

Well, there was a lot more money to be made after 1999, but when the electronic exchanges appeared on the scene, like the ISE, then things got really competitive, and there wasn’t much of a trading floor left post-2003. Options trading got very sophisticated, very fast, with the smartest, best-capitalized players able to compete with the best technology.

What You’re Competing Against

Options market makers don’t even really hedge deltas anymore on individual trades—it all goes into one big mathematical soup. It’s very hard to compete.

So, if you decide you are going to trade options, this is what you are going up against. Not to make this sound nefarious—the computers aren’t ripping you off—and there are still instances in which you can find obviously mispriced options. The computers do dumb things sometimes, but I would not go into the options markets without a shotgun and a flashlight. You should at least have a baseline knowledge about options so you know just enough to be dangerous.

The other thing I’ve found about options is that you can read about them all you want, but you really need to get your hands dirty if you are going to learn. Bonds, you can learn in a class. MBAs take bond math classes every year and get smart about bonds. There is some math, but it is not too difficult. Options, you really have to immerse yourself in order to learn.

I worked on the floor of the exchange for about 14 months, and I really needed that immersion to understand what options are all about. But back then, you didn’t need a lot of sophistication—you could buy on your bid and sell on your offer, hedge your Greeks, and just make money on theoretical edge. That isn’t possible today.

Managing Risk

The best use for options is managing risk. Like, with hedging and stuff. But let me dispel a few myths about hedging.

Everyone likes to sell covered calls. I am not a big fan. People think of covered calls as hedging. What the hell kind of hedge actually makes you get longer the stock when it goes down? That isn’t a very good hedge. 

People like to think of covered calls as harvesting income. I assure you that whatever “income” you get from selling a covered call is vastly inferior to what you will get with a coupon or dividend. With covered calls, you are never happy. If the stock goes down, you are sad. If the stock goes up, you are sad. Really, the only time you are ever happy is if the stock finishes exactly at the strike, and then you have pin risk.

Give away the upside, get all the downside, where do I sign up? Still, people get seduced by the yields on these covered call funds. If stocks go down 30%, you won’t much care about the yields. But nobody teaches this stuff.

Until now…

What I’ve tried to do is to create an options course that is designed for a specific target demographic—the smart investor who uses options directionally and needs to know how they work to acquire some level of sophistication.

There are other books out there:

• Options for Dummies—it is for dummies;

• Natenberg’s Option Volatility and Pricing—for market makers;

• And Hull’s Options, Futures, and Other Derivatives—for students.

But there has never been an options course that combines the best elements of these three texts and puts them in plain language that you can understand, replete with charts and graphs.

Now, how much would you pay for these steak knives?

I hate teasing it so much, but this is going to be really good. My partners had been on my butt for years, trying to get me to create an options masterclass, and I resisted for years, knowing how much work it was going to be. And it was a lot of work. But it will be worth it.

Coming soon.

Jared Dillian, MFA