Interview with Former CBOE Options Market Maker David Lincoln - Show #147 - Option Alpha Podcast

you're listening to the option alpha pod casts from option alpha comm where we show you how to make smarter trades learn how the stock market really works and generate consistent monthly income now your host and head trader at option alpha comm Kurt a pluses they've run this courier again from option alpha working every single week to make this the most popular investing podcast offered online because it's based on one thing and one thing only and that's helping you guys make smarter trades so again thanks so much for tuning in today on today's show I am very excited to bring to you an interview that I did with former CBOE options market maker David Lincoln and I think we had an amazing time on this podcast interview together Dave and I have been communicating back and forth for a couple months now kind of sharing stories and ideas and chatting and I invited him on the show because I thought that his experience and his background would give you guys a unique insight and look into how a market maker actually forms their duties how he kind of thought about the markets from a different perspective and I think some of the stories that you'll hear about how he went from in some cases making $100,000 a day to losing a three hundred thousand dollars in a single session and everything in between I think is really really insightful and I'm very gracious and very appreciative that David was able to jump on and spend some time with us and kind of open up as we did this interview so again as I go through this interview please pay particular attention to some of the topics and thought processes that we go through specifically how we look at David's history as far as trading kind of the differences between how market makers performed their duties previously in the past and now how technology and electronic exchanges are now changing that we also talked about all of the different trades that he's made in the past and kind of different little mini case studies with options trades with scalping trades in stock with earnings trades and a bunch of straddles at one point so a lot of different topics there and then we finally kind of end the conversation talking a lot about his specialty which is VIX and volatility trading and I think you'll really enjoy some of the insights that David has about how he kind of sees volatility trading and particularly trading products like VXX and you x/y so without further ado we're gonna get right into the interview with David Lincoln all right hey David welcome to the podcast thank you so much for being here how you doing well thanks so much Kirk for having me I'm doing great I'm really excited to be here I've been a fan of yours for many years now so it's very exciting to be on the stuff very well so well let's just start off and kind of give everyone a little bit of background on who you are and kind of your journey I guess originally to the markets you know how you got started and that whole story and then we'll work up to what you're doing today and keep going from there great well I was a SIBO market maker for many years and we were sort of the black sheep of the industry for a while because of our notoriety for taking risk and people seem to think that the CBO was a bunch of gunslingers way back in the day and maybe that was true but I got started in trading when I was young I would see pictures of people on the floor and the end of the trading day on the New York Stock Exchange and exhausted guys with paper all over the place and I thought wow that's where I really want to be and I got hooked in in college and after college as a intern for Shearson Smith Barney where I was assisting a stockbroker basically I'd have to help him find people to code call every day so what we do is we would get annual reports and we would pull the names of all the directors off the annual reports look up their numbers and this guy I worked for it was a really smooth talker I mean he if he came in the room with you he would know your second cousin and he'd be able to talk about it I mean he he was amazing on the phone but I realized working with him that I didn't want to be the one that was like raising money I wanted to be the one who was figuring out what to do with money once we had it and so eventually I ended up there I kind of worked as an intern at the stockbrokers for a while and then I went on to do other things for a little while but coincidentally a fraternity brother of mine got me a job opportunity or interview on the floor of the SIBO in Chicago so I I flew out to Chicago I actually didn't even have enough money to for the plane ticket but they they paid the plane ticket I flew out to Chicago and I didn't get that job but I was brought down to the floor of the see bow and a broker who was standing in the OEX pit there said I'll get you a job go to such and such a building and see this guy Dave Creegan and tell him that you've known hunt hammer for 21 years so I went up to the office this guy's office and I said my name is David I've known hunt hammer for 21 years the guy said how old are you I said I'm 20 years old and he said all right I'll give you a job it's 300 a week yeah the spread doesn't make sense on that you're known him for 21 years you were 20 yeah I got it yeah yeah but the floor you know it back then it was old boys network and it was the way things kind of started out was to get a runner job and I was fortunate enough to have somebody in my corner that told me like don't squander this opportunity they got me the two big trading books options as a strategic investment which is Macmillan book and Shelley natan Byrd's book and he said start learning your synthetics and start studying and so I went around to the different pits at the SIBO at the time during work what I had to do as a runner was I would bring order tickets from the broker out to the pit I was working for a company called Chicago core and I would go in hand these pieces of paper to the broker in the pit and then I have to hand back the fills once the orders were executed so I went around I went to all these different traders and I said look I'll work for free for you after the clothes finally one guy said I might know somebody who can hire you and he brought me upstairs that turned out it was him and he let me keep track of his trading cards of how many because as a market maker you basically have these big positions you'll have a stock and you'll have a position in almost every stripe every option strike so it will be so at the end of the day you have to kind of reconcile your positions every morning you get an out trade sheet which tells you if you're not matched right on trades with a broker and you have to reconcile that so I would help him with his sheets he happens to be on the same floor for Merrill Lynch as a trading firm and they ended up hiring me that's awesome so let me take a step real bit like back real quick because I want to go through some points which I think is interesting so when you say the term market maker what does that mean to you like as a guy who was a market maker what do you think about it like your core job was because I think people here market maker and they think it's you know guys that are just literally the grim reaper of regular retail traders like a person who's out there to get everybody like oh it's the market makers right but back you know 10 15 years ago or 20 years ago now I guess you know that was totally different because there's very little if any electronic trading at that point I mean you guys were literally running slips back and forth so what was it at that time to you to be tomorrow market maker well as you said back at that time we had the open outcry system exclusively which meant that you had to open your mouth to make a trade and so a broker would come in do a make a quote he would say something like SEP 21 a 3/8 and the first person to make a market that was the best market if he was a buyer if I was offered at 3 a's and the other people were offered at 1/2 if i was the first person with the best offer then i was in control of the trade and i could decide how many of the order i wanted to do and so it was definitely a it was like an auction system it was sort of like when you see those auctioneers on TV something like that but the way it was explained to me is that as a market maker we're required to make a market in size for every strike so somebody comes in with a quote i need to make a two-sided market what will I pay for something and what will I sell it for and how many will I do at that particular price but as far as like being the Grim Reaper and all that the way we saw it on the floor was that the big guys upstairs are the ones who are in control of everything like we don't really know what's going on we're just kind of trying to respond to the order flow trying to manage our risk as best we can we felt like it was the big firms upstairs that were actually in control of everything the goldman sachs is morgan stanley's those guys and we never felt like we really were insiders right and so I guess it was because order for it was coming down from them and you guys had to basically deal with order flow and try to stay balanced I guess as much as possible would that be a safe assumption yes I mean it varied from stock to stock in the very small illiquid issues if you are a market maker in the pit you were pretty much required to do whatever trades came in you couldn't just step away if a trade came in you had to do it and so the only defense you had was to either raise or lower price quickly for the next trade so that is that why you see like even even now like today's market you see somebody put in an order and then the you know pricing gets changed immediately and you're like what the heck right and you place another order and the pricing gets changed immediately again and is that mostly a factor of it being an illiquid market and you know the market makers have enough they're basically forced to take on risk so how do they compensate for that and they change price exactly and you know there was some games that were certainly played back then where people would you know sort of fade orders like you would make a two-sided market but you wanted them to do one side or the other you know maybe you would make a two-sided market but the bid you really didn't want to buy any there but you would love to sell some on the offer trying to figure out what they were they were gonna come in and do and for example some money you know sometimes at the end of the month in a stock every month they would come and they would sell the DS call and by the January 1 in the next month they would come and sell the gin and by the the Feb and so you if you kept track I would keep a notebook and keep track of what was going on you could kind of get ahead of stuff a little bit but these days it's not really like that because there's multiple exchanges there's multiple stuff trading it's electronic you can't really keep track so well of order flow but way back when you could keep track of order flow and in certain stocks you were the monopoly in the world for that stock trading options yeah that's fascinating because I think about like the world is much flatter now right like you can't you know with not only to just the increase in options volume and you know growth and reach but also technology making its you know super fast and mostly run by computers it's much flatter now - whereas you guys maybe had an idea of what order flow might come in that might be insanely hard to do now on a predicted basis yeah I mean in some ways back then it was fair in a sense that a broker could come in quote something and you would give him a market and if he came back and paid your market then you would honor that these days if it's all electronic somebody can just turn off their computer and walk away they don't want to play but you know back then we did have relationships with the firms and we did you know feel an obligation to to honor our markets so in some ways it was better in some ways it was worse I suppose yeah yeah absolutely I mean I think there's probably you know I give it a take for everything I'd still love to see more people screaming at the computer to make trades but maybe they do I just don't see hit sell okay so you got got through all that you started you know got a new position so take us from there from where we left off yeah so I was trained by one of the top firms and they sent me to San Francisco because that was their base of operations to the P Coast which was a smaller floor at that time there was the MX the SIBO the P Coast and the philic floor sort of and I was trained in several different ways mostly I was trained like sort of to look at things in several different trading ways I was exposed to different traders who had different ways of thinking about things and I was put on a seat and I was in charge of managing about 50 options positions at the same time to start with and I was in a group of six people we had to compete at mock trading in front of a blackboard to get our ticket into the trainer trading program so there was like 20 of us and after the close every day we go upstairs to the blackboard and the real traders would make market would update the stock and options prices and we would make markets and we have to sort of prove ourselves to the other people and get a spot in this program so I ended up going on to San Francisco and it was pretty intimidating I was with a Yalie Stanford guy bunch of high-powered people and usually they send five people out and forward come back usually they cut one person so it was stressful situations to be to be sure and we but we were very motivated we live and breathe options everything to do with the options our firm was was not focused on really directional trading it was more delta-neutral trading but we were very focused on like historical volatility levels on charts and also our firm was very focused on the gamemanship of being in the pit and how can you manipulate the situation to be in your favor and there's a lot of game and chip that goes on on the floors as you can imagine they were focused on that as well as just option stress but it was a high level of option strategy I would say was like about college course and math of just basic math and I spent a lot of time just doing fractions tables I'd sit there on weekends and try to because back then it was ace quarters and sixteenths and you'd have to do math quickly in your head it's always like fifth grade math whoever's the fastest at fifth grade math is successful in life that's super vastly I mean because it yeah I kind of forced you to be very very quick on your feet and so when you mean what do you mean when you mean gamesmanship in the pit so describe that a little bit just for a minute okay well there was when you first start in the pit you had to sort of it was called breaking in and so people would try to intimidate you to go somewhere else at Sasebo there were 52 different equity pits and so if you could force somebody to go away somewhere else then the pie would be divided among less people because in a sense the way it would work there was there was sort of a established pecking order in the pit and so if a hundred lot came in one person would get forty the rest that people get ten something like that and to break into a pit was hard and people were jerks to you there were fights there was intimidation all this kind of stuff and so there was a right way to go about things in a wrong way and fortunately for me I was in a big firm that had a lot of money and that helps but yeah the floor was a it was a place of characters and you had to kind of be a character to make it there you would do well there I don't know not much of a fighter but I guess maybe character but yeah that's very interesting so okay so you started so you were working with this firm you guys are doing a lot of option stuff and you're out in San Francisco yes so I was on the fence because everybody else had made some money I really hadn't made much money and I was trading a stock called system software SS ax and it was lunchtime I was in the pit and all of a sudden this thing came across the Reuters tape that their biggest customer was suing them for their product being faulty and I jumped on the phone I got I went to one firm I said so 5000 shares at the market I went on to another firm so 5000 shares at the market I went to another firm so 5,000 shares at the market and all of a sudden the stock dropped eight dollars in halted and the phone rings back your filled you sold 4,400 shares the other bad you're filled I ended up making a bunch of money on that one day over $100,000 I went upstairs everybody's patting me slapping me five blah blah blah and I had my ticket back to Chicago as a trader so that was very stressful but exciting and I started out in the Cisco pit in Chicago and I had a fairly basic strategy my strategy was to sell options before earnings so first earnings came I sold some straddles I think it worked out second earnings came I sold some straddles that worked out you can see where this is going third the fourth one I thought I was short a lot I've heard a lot of gamma and earnings was fine everything was fine and then the secretary snow came out and said something about the economy and the Dow tanked everything tanked Cisco tanked and being an inexperienced trader I had to kind of defend my short camera position so I started selling shares all the way down and then the stock whipsawed me all the way back up and ended up sort of- scalping a whole bunch of money and I gave up over $300,000 in one session which was my year yeah so it's you know people say well market makers know everything and are wired in or but if you look at my piano we had a lot of swings and it was a lot of individual incidents or individual situations many black swans little black swan ducklings yeah exactly I had another situation where I I was basically short some strata the stock was $30 I was short a straddle for $14 and this company their 1 product was FDA approval and the FDA was either gonna approve it or not and in stock 30 and you know what do you do well I didn't sleep that much that night the next day news came out the decision was delayed the straddle goes from $14 to a half dollar and it was a huge winner but you know things could have gone the other way I had things go the other way there's all kinds of stories from the floor of course so what do you think like in those you know instances right because I mean you say you like a regular person going from you know like even just further under the extreme one day you make a hundred grand on position great awesome top of the world you know another day you lose 300 grand in this session or you know during that whole position you know kind of unfolding what are the key takeaways for the regular you know average retail trader that they can take away from that say like here's how you improved or what things did you do different hour how would you look at it differently now you know now you have the benefit of hindsight yeah well I mean in in the case of being short gamma and negative scalping myself what I learned from that one was if things start to go against me when I'm let's say short a whole bunch of straddles in something if it starts to go against me I went instead of defending myself by buying or selling stock I'm gonna slowly trade options to get out of it decrease my position so instead of me selling stock on the way down what I should have been doing is maybe buying some of those puts in that I was short that way I'm not gonna get whipsawed on the other side so each situation taught me how to be more mechanical in my trade and so at this point I have a very mechanical approach like if you watch me Trey for a while you could predict how I would act on any situation because I've already sort kind of thought through what I would do in these different situations and I act in a very specific way that is not affected by my emotions of the day or or what's going on besides that which I agree with I mean like I try to do that too and I think you know like one thing I try to tell people when they sign up and you know start following the trades that I do is like after a couple months you'll pretty much understand what I'm going to do and you know people often email me and say I got into this just before you and I'm like well good cause like it was pretty cut-and-dry like what you should have done you know like there's not too much that needs to be left up to interpretation when you have most of it you know mechanical or systemized as much as possible yeah and you can do a lot of times there's the right thing to do in a situation and a lot of times you'll do the right thing but the outcome still won't be what you would have hoped for but you still did the right thing at that time given the information you have that's the toughness yeah that's the bias you know the recency bias that always creeps in it's like I did this and it should have worked but it didn't right and it was still the right decision ultimately so yeah I agree with that so all right so let's transition a little bit to now you know like I guess what your specialty is really is Vicks and volatility and kind of trading around those products so why don't you gonna walk us through let's say volatility in general and then how we can trade it and then more specifically we can get into some of the strategies that you use okay great well the great thing about the VIX is as opposed to other stocks it takes a couple of variables out of the way the VIX only goes between most of the time it only goes between about nine and 20 it can get up to like 80 or 100 but most of the time it stays within a range and it's mean reverting which means it comes back you know if you're trading square or you know in a normal stock it can get away from you one way or the other and it's gone and so you have to kind of guard against that but with the VIX you know if you if you have enough dry powder and if you have enough time it's going to come back for you which is it's a huge advantage for trading when we get into other specifics of trading options the VIX I became aware of it basically in the the mid-90s it was basically just sort of an indicator on the floor that sort of told you what the so in my mind it kind of told me what the average volatility of the stock market was at the time and it was a way lower number than than your normal equity I think when I first found out about the VIX it was trading about 18 or not trading but it was 18 and what the VIX is it is a number based on a formula of a strip of puts in the SPX so that's a huge mouthful but what it basically means is there we're looking at the prices of put options in the SPX now the SPX is I think like 80% of the trading in the world goes to the SPX it's a huge focus generally most people like if you have a 401 K or if your up savings most people are long the SPX in some way as a way of saving like when nor when most people say I don't mean to say normal but what I mean is like non trader investors no no there are normal people we consider them to be regular normal people not advanced human beings like traders are yes normal people you know say that they're in the stock market it means that they own stocks and generally in some way they own something in the SPX and so fund managers the average fund manager owns the SPX and they want to hold on to it because they want to collect the dividends from the stocks as part of the return and so if the market looks bad a certain day or month or week they don't want to sell out of their position instead what they do is they buy put options to protect themselves to the downside and so when more people are nervous that gets reflected in the put options being bid and thus the VIX goes up so that's kind of why they call the VIX the fear indicator and the VIX not being just this number that's based on some formula there's not a direct way you can trade it the only way you can trade it is by trading the futures which were developed for the VIX I think the futures were developed in like the early 2000s and but they track the VIX very poorly and in that is an opportunity for traders so when you mean track the VIX poorly because you can trade VIX like VIX options but what you're saying is you know forget those you don't want to trade I just let's say rafacz you want to trade the futures on VIX /vx right well VIX options are based on the individual futures so that's all based on the futures as well which don't track very well and VIX options if you have fixed options in a certain month they're gonna correlate to that specific month futures and people generally don't do calendar spreads in the actual VIX options but those options as well track poorly to the VIX so for example today if you look at the VIX right now it's trading 12:30 and the front month future is trading 14 and the second month future is trading 15 15 so what we look at is the relationship amongst the futures and we chart those on a graph called the term structure those are meaningful to us for a number of reasons but essentially vixx has eg FC TPS exchange-traded products excuse me exchange-traded products that that simulate the VIX that are based on the futures and so a lot of people if they want to own the VIX or short the VIX they will trade VIX atps the most well-known ones are VX x u VX y sv XY is an inverse one and that is essentially all I trade these days nice interesting ok so most of your trading is tied up in those because of the term structure and basically with VX x having to continuously sell fron and buy back right and that contango is basically deadly in most cases so how do you trade VX x and/or you VX y right so like you said i just want to get into that contango thing for a second longer oh yeah because i think people need to understand and I'd love to have you go through why it you know is you know such a drag and negative drag because we've gone over in another shows too but it's great to hear from a different side or different way of explaining it well I found with the options repetition is key to learning and with the VIX like with also just with options theory and training in general for me it took me a while of repetition before I got it for me learning about Vic about options that synthetics puts versus calls I didn't understand any of that stuff at first and it took me going through a few times over more times over and then finally stuff started to click for me and it's it works the same way with the VIX and so I I would definitely say to viewers if if stuff sounds a little bit confusing to you just stick with it because it will it will come to you it just it does take some repetition sir it's a lot of confusing terminology but honestly it's not that bad when you break it down so yeah it's the repetition that counts yeah it's totally so contango refers to the fact that as you move out in time the futures are in a state where the front month future is lower than the next month which is lower than the next month so if you if you think in your mind of a curve of all the futures moving out in time it would be like an sloping curve and they VIX ET peas that their goal and their formula is to maintain a 30-day the VIX 30 days out and the way they do that is by a mixture of the two front month futures and so first day after expiration the the second future is exactly 30 days out so you just need that one future but the next day as a day goes by that future is aged a day now it's only 29 days out and so you need to mix in another farther out future to get that 30 day horizon so every day mix each EPS they take whatever the number of days in that particular month is and so if it's 30 days in a month they take one thirtieth of their cash value and they roll it out to the next future and this act of rolling every day is called rebalancing it is really what creates drag and inefficiency and so we track every day the relationship between the first two futures and we call that contango percentage and the way it works out is if contango is 10% then that represents 10% a month that these things are going to decay and the way it works and practice is more complicated than that but essentially if you have a V X X which is $30 and all things are equal if contango is 10% it's going to decay three bucks a month so if the VIX is twelve thirty-two now and VXX is thirty dollars now then a month from now with contango of 10% VXX will be twenty seven so you've got this slow drag pulling you down and the way I found the VIX each EPS was I was looking at other leveraged etfs the gold ETFs and the natural gas ets where you have an ETF that needs to do - re leverage every day they if it's a three times ETF you get decay and those two because as things go up you're buying extra futures and as things go down you're selling extra futures and we tend to call that beta drift and we don't deal with that as much now in the VIX products because after last February a lot of these products got D leverage so there's not as much decay from beta drift as there was for example you vxy which is my major product it was a two times leverage but it was nerfed or D leveraged earlier this year so now it's only one and a half time so they did drift is not as much of a factor but contango is very important because that's something that's eating away everyday at these ETFs right and it's mostly in contango right because it doesn't always happen that way but you know the vast majority of time is that correct yeah it's about 80 to 85 percent of the time these things are in contango and if you think about it if somebody who wants to to buy protection if you want to buy insurance from somebody you're gonna have to pay a little bit of a premium so if the curve were flat then that would mean that you could buy protection for a crash or you could get along the VIX and you could just hang out forever until there was a crash and you would be guaranteed to make money so it kind of makes sense that these things would have a little bit of a of a decay on them and yeah as I said before it's about 85 percent of the time these things are in contango we had a huge event at the beginning of this year the vom again which I'm sure your viewers are familiar with yeah well I'm looking at that I'm looking at you vxy now and you know like the reason I say that is because I want people to know that it's not a slam-dunk trade all the time right like it's you know there's a pricing structure that makes it favorable to trading for someone like you or me but it doesn't mean that's always a slam-dunk because you vxy the beginning of this year I mean I guess said whatever it is right now enough they've done an adjustment or you know reverse split but went from basically eight to thirty dollars in seven days I mean it was just massive jump right so it can go sideways very quickly and like you said it it came all the way back down right to six and a half months to do that but that takes a lot of patience and commitment to ride that out I guess these effects are gradual so if you were to sort of extrapolate how much this effect at 10% contango is having on the stock per day it would be something like 2 or 3 cents so in the short term what the VIX is doing is going to affect you vxy much more orti VIX much more than these contango effects so yeah people tend to like kind of overemphasize them sometimes because they are they are there but you kind of have to be patient and pick your points for them so how would you trade them so getting to the because like how you would trade you said you tried VXX you vxy and maybe you said if I'm right you tried you vxy a little bit more how do you trade these like what's your what's the strategy behind and then we can dig down to the details well the strategy behind it is to take a ride on the short train in some way if you were to pull up a chart of these three-year chart you would see them going straight down so the question is how do you strategically short these issues and protect yourself from a big move to the upside because remember in this issue the big move is going to be to the upside it's the opposite of like the Dow or the SPX where like the crash the big move you're afraid of is like oh the markets gonna crash it's going to go straight down this is the opposite the big move you're afraid of is it's going to spike to the upside and you kind of have to guard about that at all times and that's reflected in the fact that most of these are hard to borrow stock so even if you wanted to just short shares of it it can be very difficult to do because there isn't the stock available too short mm-hmm so how would you play with options huh so what we do is we use options and I tend to to give myself a good amount of time and what I like to do is I like to wait until there is some sort of spike it may not have to be like when you were talking about where it goes from 8 to 30 but you know every couple weeks we see a little up moving the VIX the VIX you only have to look up back about two three weeks to see it it's 17 with it 12 today and so I wait for a little bit of a spike and I generally will buy put spreads put verticals somewhere between 45 to 60 days out and and you can pick how aggressive you want to be as far as high-risk trade like if you want to make a higher risk trade that has it would have a little less return you could pick selling the at the money strike and buying a higher strike in a put spread so for example you vxy right now is around 825 you might pick the November 10 8 put spread something like that for a risk reward or some people will sell a call spread you know as we know someone I call spreader buying a put spread are very similar in terms of options trading people if you want to be more aggressive you might go a little farther out and pick something like let's see like a Jan 8 put spread or a Jan 9 5 put spread where you're buying the the higher strike and selling lower one and that way I know that I have a defined risk trade where I can't you know blow out my visit I don't want to blow out my account in any way when I first started trading you vxy I was selling naked calls it can be a very profitable thing to do but you can wake up and have your account go negative one day and I don't I don't really want that to happen at this point in my life you know when I was a young kid and I didn't have responsibilities I was more of a gunslinger but these days I prefer to know what my my downside is yeah I agree I call them rodeo cowboys the people who do that like everything is good until you get bucked off right and that's really when it comes you know like everything is awesome until you get thrown off the bowl and that's that instance - so I would agree with you know if you're gonna do something in you know volatility product do it risk - fine you know know exactly what you're getting yourself into because it works and great until it doesn't right so you have that january/february spike where you know it quadruples in price and you're out in the wind basically so let me ask you this question so you do a lot of spreads would you do any just like single put buying and then buy a deeper in the money put like a 70 80 Delta put and just play that way versus a spread yeah and I like to sort of leg into a spread by doing that as well and the other thing you can think of doing is yeah buying starting out by buying it at that foot and then and then looking for something to do against it you might be selling a lower put when things move your way a little bit it might be even doing a calendar spread lately I've been looking at calendar spreads in VIX products for example in VXX if with VXX right now 28 74 I might calculate in my in my head okay VXX is going to be in a couple months it's going to be around 26 so I might actually enter into a calendar spread centered around the 26 strike so that my sort of prediction of where we're headed to is the short strike of that calendar spread or I mean the strike of the calendar spread and that way I can sort of collect a little decay as we move down because lately especially this year we've seen these things kind of stagnate for a little while and so I'm sort of careful about being long quotes for too long because they could just kind of die on the vine before I get the move I'm looking for it at times does that make sense yeah yeah so you're doing a put calendar you know say a little bit below where it's at you know trying to I guess play the fade lower right correct yeah so I've been interested in checking out calendars lately in that way trying to find a way to collect premium a little bit it's very instructive that we had that big spike at the beginning of this year because it reminds everybody that that can happen at this time last year before we had that spike I was spending a lot of my time reminding people that something can happen because I hadn't happened in awhile and people forget that something can happen it takes a little bit of patience to wait for to get that little spike before you jump on board these things but it's definitely worth your while waiting for an opportunity yeah you know I think it's I mean look we're all humans and I think most of us you know tend to have a very short-term mindset right I mean that's why we start that's why like I personally believe that we see the same thing repeat itself historically time and time again just comes in a different form but it comes down to lack of patience and being overly allocated too much risk I mean it's all the same stuff that you know happens time and time again I mean I even look at like Hawaii right now that's you know has the major hurricane what they've had five hurricane since the 1950s you know you can't tell me it's never gonna happen again that's what people thought for a long time until it does and so I look at the VIX VXX all these volatility products very much the same way as you know just wait for the you know spike if you want to play a spike and you know let it kind of come to you you know don't be out there chasing it lower because it might end up burning you if you're being super super aggressive as it's going down maybe wait for a little bit of a spike first yeah I mean I tend to think of people who like to get long this as the people who are looking for that big that big win which is sort of it's sort of the suckers playing away but there is an intelligent way to do that we one of the intelligent ways to get long and if that is your your wish would be to sort of wait until well gets kind of low at this period maybe kind of low might be 11 something like that and then to go ahead and sell some out of the money puts that are kind of below the horizon of where you think you could go to and then when you get that pop you can do something against those I love because I was a position trader for many many years I loved constructing options positions like one piece at a time like like you said maybe we put and then you look for what's the best thing I could do against that considering what's happened in the market today or yesterday or you know what's happening moving forward and I'll slowly conduct a position that way I'm not afraid to have what would turn out to be kind of like a strange-looking position that you wouldn't actually put on like all at once I'm not afraid to like kind of add to my position in a uvx wire actually in any options position by just finding out what's the next best piece in my little puzzle yeah yeah I like that I mean I think it's an interesting you know topic because you know for me like you know volatility products it on a lot of you know emotional and psychological levels as well as position sizing and timing you know that I like the idea of doing them and you know like we were talking before this like my goal is to be able to take you know what I learned from you and other people who trade them and you know create a system to be able to do it automatically and so I think it's fascinating I think it's it's crazy to me that it's actually increased in volume like volatility products like VXX have now become you know very much mainstream and they're starting to increase volume even more when we know that this is the structure of it but like you said it's those massive spikes that keep everyone honest I think that probably institutions even though it's a bad way to hedge things by getting along VIX products it's it's probably like the the least bad way for some of them to hedge things like I could imagine like a firm being sort of regulated by they had to have the risk at a certain level and so they might buy one of these for short term or for some other other reason like that I called a job hedge I think it's probably more of a job hedge you know that if any major you know fund manager money manager gets caught in a situation where the market goes and they don't have a hedge on you know that's a loser job situation right so it's kind of like that's job insurance for them you know they know that they're gonna lose potentially on it but if they don't have it in place when they need it they're gonna be out on the street well I think that your idea of your new trading program that's automated would fit really well over over Vic's products because as for a strike selection you could put in say like okay well I'm looking for an 80% success we're looking for a percent success probability and it would select certain strikes and then if you said well I'm willing to decrease that to 60% and be more aggressive because I have a feel you know I feel like balls coming in or or whatever reasons and it would change change the strikes for you because like I said when you remove a couple variables with VIX you don't have something you don't have the VIX isn't going to double and stay there it's not going to go to two either and so when you have taken away a couple variables it makes it much more easy to model with a computer system yeah that's fascinating so let's talk about position sizing real quick before we kind of wrap up on this because I think you know position sizing for me is something I harp on a lot controlling position sizing controlling risk when you trade a volatility product and if you're almost exclusively trading it how do you know or like what do you look at for position sizing to say okay this is the position size I'm going to start with or do I scale into it do I not how do you look at that that's a great question and that's one of the biggest challenges is that like a lot of people I always want to like if I think I have a good idea I always want to like put as much money as I can into it and I have to fight that even 20 years later I have to fight that to stay small and it doesn't go away we're traders we're just we're hardwired for wanting to take a rest scrap right and you know when something goes my way I think to myself oh I should have put more into that or it's just it's just natural but it's something that you have to discipline yourself on and I have to like back up and say it to myself and keep repeating to myself stay small stay small stay small because a you want to be able to put more on if things if things real yet yeah you always want to be able to put more on and that was the great thing for me about trading I was used to trading for a big firm for a long time that essentially had unlimited money and so if things got juicy you could go bigger but as an individual we don't have that we don't have that you can't just like be like ask some bank for another million dollars or something like that and so we've got to be really careful with the with the resources we have and so it's like everything else you have to say small and even more so you have to say small now that I don't sell make it calls anymore I have a little bit more of it defined risk but I look at things the way I did as a market maker which is for VIX products I look at what I'll do is for an eighty five percent up move and I also look for a 200% up move what I'll lose I also look at the downside even though that's less likely but I always look at what's the worst-case scenario and I start with what's the worst-case scenario and am I can I accept losing that much money and that's where I spend a lot of my life is in worst case scenarios so I think a lot of traders are probably that way because if you if you can guard against all the worst cases as best as you can then what's left over is profitability somewhere yeah I agree so my wife would 100% agree that I probably am in the camp of worst case scenario because but you know she handles all of our like real estate stuff that we do and at the first question out of my mouth every time it's like all right what's the worst case scenario if we you know buy this piece of property right you know no tenants the house you know we have massive flooding you know we have to replace the roof whatever if it's still okay after that okay good deal you know I agree with you so I can definitely vouch for I lived through the worst case scenarios because we've been through the flash crash that's it you know I'd tell people all the time you know if you haven't even been through the flash crash or some of these even recent volatility spikes and if you started trading in April this year things are a cakewalk from them you haven't seen anything as far as volatility so you haven't lived through one of those events to know what even happens during it so you got a you know even more so kind of pair of back yeah I mean any stock to get just back to the general market anything and having any stock at any time and you know for me I had 35 to 40 positions on for over 10 years like straight and I can vouch for that anything can happen in any situation and that's why you always got to go back to your fundamentals of options theory and stress because that's the stuff that's gonna work for you in the end it seems like oh it's a new world sometimes you see one stock that's going gangbusters up or one way or something and you think that like well it's different now but it's not it always goes back to your fundamentals and what you've learned and I'm sure what people have learned from you yeah absolutely well good man well hey David thank you so much for being here let me just ask this one final question what is there anything that we missed today like is there anything that you're like you know we should have talked about this you know to help people out any major key like reminder thing that they can watch out for to help them out well I just want to tell you that a generation of people has learned from you in options trading and pretty much every single person I talked to who's learned options in a non like non from a firm has gotten something out of your videos and your influence so a lot one of many of your fans out there and I just want to thank you on behalf of all of us for how much you've caught like a generation of people it's it's amazing it's a great honor to actually talk to you person I have to man it's all mine trust me believe me I'm humble to have you on the show and I appreciate that and by the way I did not pay you to say that I was totally off-the-cuff so I appreciate that very much yeah I love your videos for a really long time I've been watching you and I know all my buddies feel the same way so thanks so much for everything you've done for this industry I appreciate it man well listen David how can everyone reach out to you where can they find you I know you've got a YouTube channel which I've watched some of your videos we're actually going through kind of you know term structure and pricing on trades but or what's the best place that people can reach out to you if they have questions yeah so David Lincoln on YouTube I hang out in stock twits all the time under David Lincoln as well I'm at the famous Dave on Twitter and I'm very accessible reach out to me and we could talk sounds good man we'll listen I appreciate you being on the show thank you so much and we'll talk to you soon thank you Kirk thanks for listening to the option alpha podcast if you liked what you heard please drop by iTunes and leave a rating or comment plus you can get everything free email updates for future shows transcripts video tutorials case studies and more just visit our website at option alpha dot-com all right so I hope you guys truly enjoyed today's interview with David like I had said earlier in the podcast this was a an absolute treat and delight for me to have him on the show I really enjoyed it we had a really good time as you can see we laughed with sets of jokes we talked about trading we you know discuss all kinds of different topics so I hopefully you really enjoy it again if you did enjoy it please send it out to a friend share it with somebody that you know that's interested in trading or that you talk about trading with I think it's a topic and a discussion that you know needs to be heard from both sides we often hear that market makers are you know the grim reapers of the options trading world but you can see that it's not necessarily the case if you listen to today's show as always you can get more details on the podcast by heading over to optional calm slide show 147 if you want to see some more of the highlights and bullet points from today's show as well as the transcript from today's show with david again optional comm so i show 1:47 and until next time happy trading

Channel: Option Alpha

Views: 4,066

Rating: 4.869565 out of 5

Keywords: options trading basics, option, option alpha podcast, investing, podcast, investing podcasts for beginners, stock trading podcast, trading podcast for beginners, alpha, stock market, options trading, stock trading reality podcast, trading, podcast stock market for beginners, options, stock trading, options alpha podcast, options trading explained, trader, stock trading podcast for beginners, how to trade options, option trading podcast, options trading podcast, financial education

Id: 0_IdMvBVCDE

Length: 47min 35sec (2855 seconds)

Published: Thu Aug 29 2019