A migrant derivatives trader working in London talks of how he trades on volatility to buy himself financial security
He describes himself as “a third-world migrant in his early 20s from near the equator”. He worked as a derivatives trader in a small European country and now trades for a big institution in London after completing a quantitative degree in continental Europe.
“It’s funny. I am the current public bogeyman – not only am I a migrant, but I am a “banker” (deliberate use of inverted commas) too! Ironically, I can buy financial security by undertaking a job dealing with understanding insecurity and uncertainty. That’s a trade I am prepared to make.
“Fifteen years ago this job was completely different. Earlier practitioners would be standing up for ten hours in the “pit”, estimating option prices by plugging numbers into a basic calculator (big fat finger error risk!), shouting and waving hand signals. These days you sit in front of many computer screens, clicking and updating code. Lunch would occasionally be my left hand drinking soup and my right hand on the mouse. Trading options is ideal for someone who likes being in front of a screen.
“When I was working as a derivatives trader in a small European country my routine went like this: I’d come into the office just before 8am and switch on my seven screens. There are many programs to log into. I sort each data feed to update me preferentially on news in the underlying names I trade and on macro developments. I ensure my connections to all relevant exchanges are functioning. I calculate hedge limits and input them into the order book. I make sure all this is done before 8.45am, as the market opens at 9am. At 9.01am there can be some juicy trades – you want to be fast. I would leave around 6.30pm. Weekends were free.
“It doesn’t matter how much of a mathematical genius you are – when you first come in the challenge is learning how all the systems work. It’s more about systems now than ever before.
“I could trade options without knowing the exact proofs of their pricing. The model does that for you. It’s like trading cars. You don’t need to know every last detail of how, say, the piston works. What the firm wants is someone quick, assertive, mathematically competent, prepared to optimise reward/risk ratios.
“Some derivatives traders take nearly three hours every day to calculate the value of their positions and their P&L – I saw it in inflation instruments, but I don’t know exactly how all of them work. There may be “options on options”, “path-dependent options”, “correlation products” and much more.
“You’re asking how a risk manager would oversee a dozen traders like that, each in his own field. Well, as an options trader you are your own risk manager – particularly at a smaller firm. I wasn’t at a company with a big retail division attached to it. If we screw up then we take the hit (as we should!), as do the (wealthy) investors in the firm. No bailouts for us. In general the more complex and opaque the product, the more a trader needs to act as a risk manager. He may be one of the few people who fully understand the risks, though I think larger institutions have been bulking up with sharp risk managers of late, who don’t just hold their tongues.
“You don’t see people doing this work their whole lives. Trading can take over your life – but only if you let it! It can be surprisingly tiring staring at a screen intently for hours, clicking every few seconds. But being a fisherman in Comoros, a paramedic in Eritrea or a lumberjack in Zaire must be way more tiring, surely?
“Some people in finance can exaggerate a lot. I want to emphasise that to the readers. It’s not that stressful! I had my evenings free. I could relax. I could play sport. Sure – I work hard, but so do many billions of people and for far less pay too. I could basically manage my housework myself too, so it couldn’t have been that draining. Most important to me as a migrant worker was that I could save over 50% of my net salary – this is really lucky coming from a continent where 25% of people in my age group are unemployed and even more have no savings. I am very fortunate.
“Things seem very different in London, where finance is more of a lifestyle and a mentality. In northern Europe (possibly excluding Frankfurt) working in finance did not set you apart from society.
“In London if you don’t join your mates for a drink after work, it can be seen as a signal of disinterest. There’s a big culture of spending and splashing out. And job security is probably worse. Where I worked in northern Europe, people conceal their wealth. Ostentatious behaviour is socially unacceptable. There isn’t any discrimination towards the back office. Seniors don’t make juniors get food orders. No need for pinstripes. “It was completely natural for the secretary to join us for a drink. And it wasn’t like London where sometimes you can’t take your full annual leave without worrying what signal that may send out.
“From a lifestyle perspective I believe you have to be flexible. As migrants we are ideally placed to do that. Big institutions are still prepared to offer us work visa sponsorship. If I stayed in northern Europe for too long I might be pigeonholed. You can live a comfortable life. But at some point in your career you tend to gravitate to one of the “hubs” (London, New York, Hong Kong, Singapore).
“I just can’t plan my career more than two years ahead. The industry can change quickly anyway – for example, suppose you were trading in Sweden before the financial transactions tax came in. After it was extended in 1989 to cover a wider range of instruments, 98% of volumes in bond derivatives in Stockholm went elsewhere. Imagine you had been trading such products, but had married a local woman who insisted on staying put. What do you do? Will you get another similar job in a niche market if you aren’t prepared to migrate? Will you even be the first choice to be hired when volumes come back? Now imagine you are a migrant – probably a single man – no wife, no kids, no house, just savings. It’s easier for us, isn’t it?
“If you’re mid-level and you get laid off, it can be very difficult to get back in. Some financiers in London over-leverage themselves and save virtually nothing, despite their high salaries.
“I don’t understand how they can’t apply the same rules of risk management to their personal lives as they do in their professional lives. How could they be so over-confident?
I don’t think the state steps in to help that much in the Anglo-Saxon world compared to continental Europe (I’m talking about stepping in to help individuals here rather than banks!) Many migrants are from nations where there is no welfare state, so we plan for redundancy. We price it in.
“Let’s dig a little deeper into my job. There is very little information asymmetry anymore. Everyone has the same Bloomberg terminal, same market feed and (nearly) the same variant of the “Black-Scholes” model for pricing options. Making small margins on each trade is critical.
“The “algos” or high frequency computers will always trade faster than a human can. Most of your systems are executing the quick, “scalp” trades for you – your human input is how you programme it to hedge your exposure, and at what level you choose to take on a block trade.
“If you are a market-maker you are obliged to continually make live quotes in a pre-specified range of options, over a range of strikes and expirations. In return for providing this liquidity we can receive a rebate from the exchange.
“Trading options is a reductionist activity: you condense the underlying instrument’s price, the strike (exercise level), contract duration, prevailing market interest rates, stock borrowing rates, dividend expectations and volatility into two numbers – your bid price (where you are prepared to buy at) and your offer price (where you are prepared to sell at). The first three inputs I mentioned are all known – it’s only really the volatility you’re that unsure of.
“That’s essentially what we’re trading – volatility, hence our name – “vol” traders. You want to get as big a spread as possible on each trade – but if you quote too wide your prices won’t be competitive and nobody will trade with you. You need to find a balance between getting execution and minimising your adverse selection probability (that’s your chance of being “picked off” when the market moves uni-directionally).
“There are lots of parameters you need to monitor, and thus lots of ways you can make (and lose) money. Firstly I look at option “greeks” (first-order derivatives such as “delta”, “vega”, “theta” and “rho” and then second-order derivatives like “gamma”, “vanna” and “charm”). When you’re trading “vol” (the annualised standard deviation of returns of the underlying instrument) you’re hypothesising how much an instrument is going to move. You want to optimise your various ratios (gamma/theta) at different strikes to ensure that you have bought and sold optionality at good levels.
“Secondly, I want to make relative value trades between components in the same index or in the same business sector: eg how is volatility priced at the 25% delta put option in this French oil company versus the 25% downside in that Spanish oil company? Does it seem fair? Where has the spread been historically? How divergent are the skews in the volatility smile? How quickly have I noticed this? Can I trade? Have I been fast enough in identifying an anomaly and monetising it? If and when I do, it is back to dynamic hedging, responding to broker requests from our sales traders, coding and repricing in line with new market developments. Depending on how fast your systems are you can implement volatility arbitrage strategies too. It’s like playing Gran Turismo but your gear changes on the controls are manual. Not automatic.
“Vanilla” options are contracts giving you the right (but not obligation) to buy (call) or sell (put) an underlying stock, index future, commodity future or bond future at a particular level and at a particular (series of) moment(s). When the duration of an option contract runs out, it “expires”. When that particular ‘expiration’ moment arrives, it’s incredibly tense. One evening every month I’d be like: “Don’t bother me because I’ll just ignore you.” Imagine having to analyse between seven and ten names between 5.30pm and 5.35pm and ensure that you hedge your “delta” exposure on each one.
Those five minutes are the auction, where market participants determine the closing price. That affects if an option is “in the money” or “out of the money” – ie whether it will be exercised or not.
“Probably the most turbulent time was over the summer of 2011 when it was believed that Greece might default. For three days I just reserved one of my screens to show televised footage of Greek parliamentary votes – that was the market barometer at the time.
“You only saw buyers on the screens – people were too afraid to sell. But I am required to quote prices. I have to react fast enough to keep an offer price at a safe enough level. At times like that it’s not about stocks anymore – what moves markets is macro news. All it takes is for the likes of Ben Bernanke (US Federal Reserve chairman) or Mario Draghi (ECB president) to be a little bit hesitant.
“Sometimes there’s a deep sense of powerlessness. Suppose I have a short gamma position (ie I’ve sold volatility) in an airline company. That company issues a profit warning at 8.58am and the options market only opens at 9.01am. I know that a profit warning means the price will dive (in general, the smaller the market capitaliaation, the bigger the drop), but there’s nothing I can do in those three minutes but re-price my options, my term structure and put in some respectable bids so I can buy back option premium. Oh – and I need to sell some stocks fast to minimise the size of my “long delta” position I get from being short on options.”
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