Finance Simplified EP 29: Simplifying Options Pt.1 with Tom Sosnoff of tastytrade

what's up everyone welcome to another episode of finance simplified the official podcast for street fins we're here to break down the world of finance for you to understand from a relatable perspective with discussions with experts my name is rohan and this is episode 29. my co-host alex is currently on vacation in iceland so he's unfortunately not able to join us today for the intro and outro but you'll hear him in the rest of the episode as a result i'll keep this episode's intro short the topic of today's episode is simplifying options options are a type of investment that have become very popular especially as of late this episode will dive into the basics of options we'll be making this topic a two-part conversation so this episode is part one and we'll be releasing part two in two weeks from when this drops additionally we just want to remind you that if you are learning from our episodes and want to keep supporting what we're doing we'd be eternally grateful if you gave us a five-star rating and review on apple podcasts we'd also really love to know what feedback you have for us so join our discord channel to let us know how we're doing and what you would like to see from us going forward we'll be teasing the next guest at the end of part two our guest is a well-known expert on options and an entrepreneur in the financial industry so let's just get to simplifying welcome to finance simplified the official podcast for street fins created by students that simplifies the seemingly complex and confusing world of money we're your hosts rohan and alex [Music] options are a popular and well-known investment that many investors both retail and institutional trade the options market options stock options our guest today is tom sosnoff he's a well-known name in the financial industry having co-founded the famous trading platform thinkorswim his background and career are both so impressive that i think i'll just let him introduce himself sure my name is tom salazanov i've kind of been around the option world for four decades i currently am the ceo of tastytrade and we are an online digital financial network we also own a brokerage firm called tastyworks which is one of the fastest growing brokerage firms in america about 98 of our businesses options futures digital assets and options on futures so we're pretty much one of the leading boutiques in the world of derivatives trading for self-directed investors that's awesome to hear and you know you're talking about tasty trade but the other thing that you're really well known for is being the founder of think or swim and a lot of people in finance know if think or swim now as it's td ameritrades kind of educational trading platform in a sense so how did you kind of get interested in finance what drove you towards finance and to founding think or swim well when i went to school which was like in another when dinosaurs roamed the earth you know compared to you guys it was late 70s and we really didn't have finance majors you couldn't major in finance there really wasn't a business degree there was economics and there were versions of math and things like that but there wasn't you know we don't have the same choices you have today there was no entrepreneurship degrees or things like that so my undergraduate work was in political science and i always thought i was going to be some kind of government lobbyists international government whatever it was and when i got out of school it was the middle of a recession and the only job interview i got was with a company called drexel burnham which was a really large boutique brokerage firm on wall street and they offered me a job so i took it and i've been in this industry ever since so sometimes you know the best laid plants don't come out exactly what they're supposed to be i never bought a stock or traded an option or really made a trade before i started at drexel in like 1980 and i've never left the business since so it's been a little over 40 years and this is all i've ever done i left my job early on at drexel to move to chicago to trade on the floor of the cboe and i've basically been here ever since yeah that's fantastic thanks for that intro and you know i think it's really interesting how you've carved out your own niche and finance that's really awesome i kind of want to get into options could you explain for you know maybe viewers who don't understand options i've never really heard of options or derivatives what is an option in the most basic sense options were originally created as a leveraged alternative to buying stocks somebody came up with the idea okay well instead of putting up 100 of the capitals required to buy a stock let's put up a small amount of money let's have a certain expiration date and some different strike prices and let's create a way where you can participate in the upside with the shorter duration expiring environment and so options were created as a directional leveraged speculative bet they have since become something very very different which is a capital efficient strategic way to play different underlyings you can be right and and lose money you can be wrong and make money they are the only financial instrument that is actively traded liquid efficient and at the same time completely strategic so i think that that's the neatest part about options and again when i started i didn't know any of this stuff i had to figure it out kind of on a fly and so you know it's taken me a while i'm a slow learner yeah and could you maybe break down the two basic types of options so the call option and the put option you know maybe how would they be used in sort of a retail sense is there maybe a scenario you can use that might illustrate how they'd best be used well a call option is the right to buy a stock by a certain date at a certain price and put options the right to sell stock a certain date certain price and that was kind of in the most traditional of definitions you know that's how people used options as a way to get directionally long or short without having to get long or short to stock and so it was another way to kind of play the stock market options have grown dramatically and dynamically in the last you know 40 years i like i said i started in 1980 or 1981 on the floor of the sibo and i mean they had just introduced puts a few years earlier now you know things are when we built thinkorswim in 1999 2000 you couldn't even execute a spread order electronically and now we do 200 000 spreads a day through our platform so we've changed the industry through the introduction of some really cool technology but the most important thing to know about options in 2021 especially for your listeners is that just think of stocks as being really expensive and options as being very capital efficient so who asked that question alex or rohan which one of you guys yeah yeah that was me okay alex so let's say how old are you so 19 19. ron how old are you same age 19. okay so let's say you guys it's reasonable to assume as to 19 year olds that you don't have unlimited capital i'm just assuming okay it's a reasonable assumption right you don't have unlimited capital you have not got to the point in your life yet where you've created the wealth that you're going to create over the rest of your life so you come into a situation and you get to school one day and you're talking you're like you know what i really love the stuff that amazon's doing or you really hate it either way i don't care which way it is you love it or hate it and you look at each other and you go but how do we trade amazon it's a 3700 well right now today closed at let's say over 3 500 so to trade 100 shares of amazon is 350 dollars it's unrealistic that two 19 year olds or 22 year olds or 30 year olds even for that matter are gonna spend a hundred thousand dollars to trade a hundred shares of amazon so what are your choices well you can trade one share or 10 shares let's say for you know 35 000 or one share for 3 500 or a fractional share which makes absolutely no sense to me or you could potentially trade the theoretical equivalent of some amount of stock for significantly less like for example if you're bearish you could buy an at the money put spread in amazon and pay 200 for it or 150 for it if you're bullish you can buy at the money put spread and pay 220 for it and you know it'll be five dollars wide or something or you can buy an out of the money call spread and you can pay 150 support so you can actually trade amazon for 150 to 250 or whatever you want to spend so the options they kind of legitimize finance especially for your generation because they allow you to play in an arena that otherwise would be out priced or out of reach because of price that's why you see platforms like robinhood for example or weeble for example that are free platforms you know doing 60 70 of their business and options because people can afford to trade them and they're much more capital efficient that's the simplest answer i can get oh that's a fantastic answer and you know so we talked about the one which is you're paying premiums to purchase you know maybe a call option or a put option but the other side of it is sort of this time element and so i think part of the inherent risk of options and let me know if you agree with me or not is you have to be right but you have to be right at the right time especially if you're buying sort of short dated options can you kind of speak to the risk of playing options like that and maybe what are your summer personal beliefs for retail investors or young investors and on how to play options absolutely and so let's understand that when you have an efficient marketplace because one of the most misunderstood things about options is that they have this inherent risk in of time value right because that's kind of what you're thinking well you know the nice thing about stocks is you can theoretically hold them forever once you pay for them and with options you can't because they have this time value or this time decay however you want to think about it it's the right of that level of premium is what you pay for the right to have that leverage so in order to be able to lever up anything you've got to give somebody else the opportunity to make it attractive to sell you that right and so the great thing about options is because they're so efficient and most of the markets are you know one two or three pennies wide you can take either side of that trade so if you don't like the idea of buying premium because you think that the time decay is too negative it's not something that interests you and you want to take the other side go ahead and take the other side you know there are certain one-sided markets in the world like different gambling different bets you can make in sports and different casino bets you can make where the markets are very one-sided but in the world of derivatives whether it be stock options futures futures options in any of those massive marketplaces which is you know multi-trillion dollar marketplaces you can take either side so the efficiency the beauty of the products is the efficiency of being able to be long or short either way yeah no that's a great point and we're actually going to discuss sort of this distinction between going long buying maybe a call option and actually selling covered calls or selling cash secured puts um in a little bit but i kind of want to transition from sort of this retail sense because we've really been focused on the retail trader to maybe a corporate environment so you know a company and maybe they want to hedge through options could you explain how options are used in the corporate world maybe through futures contracts well listed stock options are rarely used they're used in the institutional world from institutional money managers and obviously prop traders and market makers and things like that most companies are restricted by their boards from using options so companies can't necessarily sell options against their own holdings you know against their treasury stock or against their own holdings or take speculative bets because there's too many ethical questions and there's too many potential material breaches in there of non-public information so most companies stay away from the option marketplace there are some companies that are dependent on different commodities to hedge for example like that that was sort of my question was futures contracts sure so there are different commodities like for example you know you can take an airline when prices of crude oil get super cheap they might want to lock in some of those high premiums on the put side or some of those low prices via the call side or there's different strategies they can use to lock in you know long-term purchases they know they're going to be buying things there's certain producers like home builders that might want to you know lock in lumber prices or farmers that might want to sell future crops like future corn future wheat future soybeans or you know there are other ones that might want to buy stuff like copper when it gets real cheap you know because they know they're going to need copper for building so there are lots of different commodities and then of course there's even index like products for mutual funds for hedge funds for bond funds things like that where they want to sell some premium when it gets expensive or sell some volatility when it gets expensive you know against corresponding portfolios so there's lots of potential hedges in that regard individual corporations not so much unless they're hedging a specific commodity but yeah you're spot on you know the great thing about options is whether you're doing a futures option or whether you're doing a listed equity option the pricing model whatever variation of black shells they're using the models are essentially the same and they're incredibly efficient because there's so much money chasing higher returns and they're chasing alpha essentially that bottom line is it doesn't matter what underlying product you're looking at as long as there's liquidity to that product the markets are going to be efficient that's a great example and thanks for having that i think it is really interesting that this idea of sort of hedging and buying contracts whether it's options or futures is really something that's pervasive across finance whether that's you know corporate finance for hedging through certain commodities or even just retail traders wanting to hedge their positions or even just make their position in the market clear through options so thanks for breaking that down and you know options it seems very complicated to the retail investor and you know if you're new to finance options you know very difficult to understand there's exotic plain vanilla american european and there's just all these complex terms and you know pricing's hard to understand there's the greeks if you were to tell maybe a retail trader or try to explain to them how would you sort of break down options and how would you advise them if they do want to try you know in trade options sure so well first of all you know you're right in the sense that options because they're the most strategic are also the most complex of all financial instruments it's because they are not black and white it's because they are not static it's because by definition they're dynamic and so the first thing i'd say is that you have to be on a strong technology platform so one of the things like that we do is you know when we built thinkorswim we really changed the industry with respect to building software that would help individual investors navigate you know complex derivatives products and complex derivative strategies like options and futures and you know the thinkers and platform was a game changer and we spent 10 years of our lives just building that platform we were public companies so we got bought out by td ameritrade who's eventually got bought out by schwab so now it's a schwa platform but it's old and now we went on to build tasty works and these platforms are very intuitive and the way they're designed they make you know complex products really simple in that regard so that's one thing you improve the technology the second thing is you reduce fees which we've essentially done across the board the third thing is you get better markets so there's no bid ask so the bid ass differential is incredibly tight so that individual investors don't feel like they're getting ripped off by you know wide markets because the markets are only a couple pennies wide so you solve some major problems right up front you have great technology low prices great markets then what you do is you know a firm like tasty trade comes along and we create free content that is all quantitative in nature so no we know this is going to happen that's going to happen all just mathematical all quant based statistics and probabilistic content that changes the way people really look at and understand you got to realize something most people are super smart and when you take super smart people and you give them a mathematical approach to something all of a sudden their eyes light up and they're like i can do this this is not that complicated and the truth is it's not that complicated and they can do it and so you add to low prices you add to efficient markets you add to great technology some great content and then all of a sudden you're able to bridge a lot of the challenges and then really what are you asking somebody to do you're asking them just check it out just see if it works you know what just make a trade and see if you like it and you can stay super small yeah i know that's really awesome because you know you're talking about if you kind of simplify the mathematics of it a lot more people are going to start playing in it and obviously one of the bigger kind of mathematical hurdles to come over is this idea of options pricing so let's kind of delve into that so most people in finance and if they hear about and if they're learning about options they'll undoubtedly come across the the black shoals model and it kind of as like the king of option pricing models so how should we begin to understand that like what are the main variables i'm thinking maybe like volatility interest rates you know the greeks things like that how should we just begin to understand that in a simple sense you're right there's only you know a handful of variables that go into computing black shells which ultimately spits out something we call implied volatility which is both a measure of fear and expected move and then implied volatility is generated is that number that's backed into off bid-ass differential so what you have is a competitive marketplace that generates a volatility number that fits inside of a black shells model that you add to that duration interest rates strike price and next thing you know you know you've got pretty accurate theoretical pricing and firms can adjust accordingly and the nice thing is it's consistent across multiple products and the other thing is there's so much competition for market making that in the end pricing is just you know i mean it's not even off by a quarter of a cent anymore there's no inefficiency in it whatsoever what i will say is like if you guys want to go we have a couple of mathematicians that work for us and our site we do a segment called the skinny on options map and the lead a phd from the university of chicago named jacob perlman who's a brilliant mathematician we've broken down every aspect of black shells from black shells from you know actual brownian bridges all the way back to kind of like you know second and third level derivatives and we have some incredibly brilliant you know just data scientists and mathematicians and physicists that really break down the simplicity and also the efficiency of black shells you know in its traditional sense in a proprietary sense and i encourage you to go it's all free archives and on the tasty trade site and you can just google the the skinny and option math jacobroman and black scholes and you'll find some of the greatest content you've ever seen on the topic he's you know out there and it's all just optimized math modeling hey everyone that was the end of part one of our two-part interview with tom sosenoff on simplifying options we'll be releasing part two of our interview in about two weeks from when this releases but the first half of the conversation was absolutely incredible here are some of my key takeaways the first takeaway is that options appeal to investors and traders because they are a strategic and capital efficient way to bet rather than buy a stock for hundreds of dollars options provide a much cheaper way to capitalize on market movements this leads to our second takeaway which is that the two main factors to keep in mind are time and volatility with options after all volatility is the best measure of if an option will reach its strike price before its expiration date the final takeaway is that like all things in finance options while they seem complex can be broken down into simple ideas that can later be rebuilt into more complex concepts like pricing equations and trading strategies both of which will be covered in the next part part two will be dropping on september 15th which is two weeks from now we'll talk to you all then [Music] hey guys i want to thank you so much for listening to this episode of the podcast it truly means the world to us if you liked this episode and others let us know by subscribing and giving us five stars on apple podcast and following us on spotify share us with your friends and check us out on instagram and twitter both at streetfins you can also follow me on twitter at rowhuntinvest if you'd like to get in touch with us please email fspodcast streetfins.com thanks once again to tom sosnoff for his insights today i hope you understand the topic of options in a more simplified way i also want to thank jeffrey lee for his amazing audio editing skills and for having edited our audio for the past year once again we're really happy that you're taking the initiative to learn finance and to better your future if you haven't already we highly encourage you to check out streetfins.com for articles videos and other content join the street fins community and tell your friends about us so that they can learn about finance too we'll talk to you next time on finance simplified

Channel: StreetFins

Views: 103

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Id: ADoQxMj6lQQ

Length: 22min 21sec (1341 seconds)

Published: Wed Sep 15 2021