I’m pleased to present the following interview I conducted with Dr. Mark Wolfinger, an expert on options trading. Mark has decades of experience as a professional options trader and has written three books on options, on top of maintaining his own blog for investors interested in learning more about option trading. My questions appear in bold, and Mark’s answers appear in plain text.
Mark, you have more than 30 years experience trading options. How have the options markets evolved since you first began?
Night and day! When I started as a CBOE market maker in 1977, we only had call options. Puts did not begin trading until later, and that made hedging more difficult. But everyone was much less sophisticated in those days. We had computer help in determining the theoretical value of an option, but if I wanted to hedge an options trade with stock, I had to call my clearing firm’s desk (clearing firm is to a market maker as a broker is to an individual investor) and have them place the order by phone. Slow process, and there were no immediate fills. We also had to do everything in our heads or with pencil and paper. That includes keeping track of positions, estimating our position delta and gamma etc. That lack of sophistication gave the floor traders an edge over most individuals, but it was much more difficult to minimize risk. We had to do the best we could. Today computers crunch all the numbers instantly.
It’s also very different from the perspective of an individual trader. Being able to see all the bids and offers in real time, the ability to receive fills in less than one second, the ability to see my Greeks instantaneously [for more information on ‘greeks’ as they relate to options click here] – all makes trading and managing risk so much easier. And commission costs are so low that I pay less as a customer today than I did as a new market maker in 1977!
You spent more than 20 years as a market maker – can you describe briefly what a market maker does?
A market maker makes markets! Thus, when a broker (representing an order from his/her customer) enters the trading pit and asks for a quote on a specific option or spread, the market makers announce a price at which he/she is willing to buy the option quoted (that’s the bid price) as well as an ask price (price at which willing to sell). That must be done for every option that trades in the pit. When I started there were three or four stocks and a bunch of market makers in each pit. The most actively traded options, such as IBM attracted the most market makers, but no pit was vacant. The market makers were supposed to compete amongst themselves to present the highest bid or the lowest offer in order to get the broker (who represented the customer order) to trade with them. Obviously when selling, the broker chose the highest bid. Our bids and offers were posted for all to see, but it was a manual process. When the price of the underlying stock changed, we had to change all the option quotes. That was certainly a nuisance. Today, those bid and ask prices are established by computers. The parameters used to make those bids and offers are established by the specialists and the quotes change as the stock price changes. Much more efficient today.
Many readers of this blog are curious about careers in the financial sector. In today’s world, what qualifications would be necessary to become a professional options trader and what kind of income could someone expect in that career?
I have no idea. The world has changed dramatically since I left the CBOE eight years ago. It’s difficult to get started as an independent market maker. Most now work for large trading firms. Income would vary from poverty level to wealth, depending on the skill of both the individual trader and his or her partner (trading firm). There are proprietary firms that teach and hire traders, but most charge enormous fees to teach, and I simply have no way of knowing how the process works after one is ‘taught.’
Do you have any preferred option trading strategies that you use on a regular basis?
I believe in keeping it simple. When I write, I describe easy to learn, uncomplicated strategies, and those are the only methods I use with my own trading. Right now, I buy iron condors (on broad based indexes) exclusively. When implied volatilites are low (at least low in my opinion), I add double diagonals to my trading arsenal. If I had a strong market opinion, I would still trade iron condors, but ‘lean’ my positions in favor of that bias. I never have such a bias (history has convinced me I am unable to correctly predict direction), but I mention that for your readers who do. I used covered call writing and cash-secured naked put selling for years and believe that’s a decent strategy for people who want to learn how options work. But, those are bullish methods and do not perform well in down markets.
I know that you are an ardent proponent of investors educating themselves and experimenting with paper-trading before putting real money on the line – do you have any recommendations for sites that allow for good paper-trading of option strategies?
No. If an investor’s broker does not offer such capability – at no cost – then it’s time to get a new broker. One extra reason for using a broker to paper trade is that you gain familiarity with the broker’s order entry system and risk management tools. That’s important because you never want to enter an order backwards (selling when you intend to buy) – and that can happen if the trading software is unfamiliar. Because risk management is crucial to long-term success (IMHO) when paper-trading it’s a good time to become very familiar with those risk management tools. To me those tools must include risk graphs and the ability to monitor position ‘Greeks.’
I’ve noticed that the notional interest in derivative products (equities, indices, interest rates, etc) has just exploded in the last five to ten years, and the rate of growth seems to be increasing to boot. Do you have any thoughts as to why the derivative market is growing faster than the traditional equity and fixed income markets? Is this a red flag?
This record-setting pace is continuing this year. I cannot know for certain, but my belief is that more and more institutions are using derivatives. The amazing profits of hedge funds appears to be a thing of the past, but more and more hedge funds are in business, and they use derivatives on a constant basis. I’m sure the number of individuals who use options is growing as well, but I don’t believe they contribute significantly to the total option volume – which will top 3 billion contracts this year. I don’t see a ‘red flag.’ Bubbles occur all the time, but increased volume should not be such a bubble. Remember that options were designed as risk-reducing tools, and if used that way, nothing terrible should happen to ‘the markets.’ However, as we have seen with Barings Bank, and especially Long-Term Capital Management etc, rogue traders or intelligent trading firms can lose enough money to shake confidence in the entire system.
There seems to be numerous “option seminars” out there that promise to teach people how to trade options based on either proprietary trading algorithms or just a set of rules to follow blindly – in my mind, it seems that these ‘systems’ skip over the fundamental knowledge and understanding required to prudently trade options – which I think is a philosophy that you share: i.e investors need to educate themselves properly first, practice second and then use common sense when trading. What’s your advice to the would-be option trading investor who is just thinking about getting into options?
Those firms that sell costly seminars are out to make money, not educate profitable traders. Consider this: If they had great proprietary methods, they would never sell those methods to anyone at any price. Thus, to me, those algorithms and trading rules are not worth much. To the extent they ‘teach’ the investor to think for him/herself, they may be worth something. But, I’d avoid them as overly expensive and simply a bad idea. The problem is that too many fall for the hype of a ‘get-rich-quick’ scheme and take these classes. Anyone can get lucky, so some people make instant riches. But, the vast majority fall by the wayside. These seminars give the options world a bad name.
I believe, as you say, that each investor should learn for himself. It’s not complicated to adopt the simple strategies I encourage. My recent book: The Rookie’s Guide to Options, provides a detailed explanation of how options work and the benefits of using options. It provides details that allow the reader to learn to use options. By ‘learn’ I mean to think for him/herself and really understand how options work. I stress the importance of risk management. Others may tell a reader how to open a trade, but I discuss opening, managing and closing positions. The goal is long-term profits, not instant riches.
Advice: Go slowly. Read. Paper trade. Ask questions. When using real money, start small. Don’t allow ego to get in the way. If you don’t yet understand what you are trying to accomplish with each trade – and what can go wrong – you are not yet ready to use real money. Again, be patient. You have the rest of your life to trade.
Thanks for taking the time to participate in this interview Mark.
My pleasure. I appreciate what you are trying to do for your readers.
UPDATE: Mark and four of the other top options bloggers on the internet have set up a paid educational site designed for those interested in really learning about trading options for the first time, as well as providing advanced material for those who have been trading options for years. Click here to learn more.
For those who are interested in learning more, make sure to check out Mark’s website (http://www.mdwoptions.com) and his blog (http://blog.mdwoptions.com/options_for_rookies/). Both contain links to a free ebook, which is a sampler version of his most recent book. In total, Mark has authored three books on options which are available through Amazon.com
I really enjoyed this interview.