Trading on Monday

Lonya arrives
Lonya has been here for a couple of days now. The top picture is him in the train that goes from Schipol Airport (I picked him up because I am good guy). The picture below is meant to indicate how comfortable Amsterdam is for us. If he didn't have a life back home, he would stay here for quite a while longer. He likes the free feeling of Amsterdam as much as I do.

Art vs. Science
Many people, with all too much pride, explain that what they do is an art and not a science. This type of thinking assumes that science is something that is simple because it has rules and art is difficult because it requires the creativity. This implies that Newton engaged in art since his science was not yet science and implies that middle schoolers in art class who are taught to work with certain materials are actually performing science (because they are following the teachers rules). How boring science is!

I categorically disagree with this definition of science. Science is the way that people discover new things and check them so they can rely on their observations. Science is the way that people systematically add elements together to create something totally new. Science is the way that a choreographer reuses elements that elicit reactions from the audience or reuses elements to put dancers into a certain position from which they can express something better. There is no reason to assume that science covers only linear or expected outcomes. Combinations of elements in chemistry create compounds with entirely different properties.

Chemistry, art or science? Every pursuit is both art and science.

Finance: Art or Science?
I won't surprise you by saying that I believe finance, like pretty much everything else, is both art and science. First, you learn the rules (as could be established as scientifically as possible). Then you practice playing by the rules and learn what is not truly set in stone. Most things are not set in stone: volatility does not have to fall when the underlying price rises; stocks do not have to act log normally (more about this below); correlations are not a rule; a spread trade is a risky bet, not a sure thing.

And if you are a great artist, you develop something that people will use later. You will develop science. The better you think the more you'll be able to contribute to making what you do a "science." (this topic is covered quite exhaustively in Sparks of Genius)

How to discuss art. (slash why talking in outputs is terrible)
When discussing a financial topic with someone, keep in mind whether the particular topic you are talking about is a topic that is an established rule or something that just has arguments for and against. (A model does not have everything built in and does not work all the time). Unlike in engineering (or physics), you cannot just say some numeric or boolean answer and be satisfied. A true conversation about something that can act randomly requires balancing pros and cons, and re-balancing all the time. (Yes and no is very useful in operational mode, when you want someone to understand exactly what you want him or her to do.)

Since, the assumptions in finance are ever changing and the behavior of markets are under constant flux, you should strive to understand something as fully as possible. That means you should examine all the arguments that push something one way or the other. For example, if I ask what will happen to the underlying price when the volatility increases, and you answer the price drops, then you have missed the point. You must say why you think the price will drop.

In the same way, if you ask whether someone is democrat or republican, you do not yet know anything about them. You know whether they agree with what you currently are willing to believe but since you do not know why they made that choice you know too little to make any sort or judgment.

In that way, finance is a lot like marketing or psychology. Empirical studies are important but will not give you rules to follow. Instead, asking why is important.


Preschool Graduation
It has been 3 weeks since the program began. Most of the trainees are relatively fluent with the Option Volatility and Pricing book and many other topics like currency risk. We have spent a couple of days watching the previous two classes of trainees trade. The batch in front of ours is very talented and got promoted to the real trading floors. Though the graduated trainees (not my batch) are all pleased with which desk they will be sitting, they had no part in determining at which desk they will be working.

My batch gets to trade tomorrow, which means that it is now time to read all the books on how to control your emotions while trading. (Thank you poker for teaching me to deal with chance, especially bad beats.) Learning the theory well beforehand allows one the time to read about subjects that not all programs think are mandatory like 'how to get into the zone or emotion free trading.' Some of these subjects that interest me, but don't necessarily has established answers, are below.

Friends come in

Moving away from 'home', whether it be away from where your parents live, where you went to school, or where you have grown accustomed to, is always a hassle. The upside, of course, is that you get to make more places in the world your home. Friends and family are a phone call and a flight away.

Some choose to take that flight. Yesterday, a friend came in to see the US trader that I hang out with often. They went to a Casino and the Trader helped Phil Ivey sign in. If you know me, then you know how I dislike celebrity, but this is cool. Phil Ivey is one of the best Poker players in the world, regarded as highly loose and aggressive.

Today, we will experience my top 5 reasons why Amsterdam is the best place for friends to come visit.

1. The rules are different than any other place in the world. To visit other places is to experience other cultures firsthand. Where else can you visit the red light district and talk about the 'philosophical' implications at a coffeeshop.
2. Museums: Heineken museum, Van Gogh, Rembrandt, Anne Frank's house
   
3. All you need to get around is your own two feet. Take a tram anywhere you want to go in the city. Fly to Italy, Istanbul, or London for cheap. Take a train to Brussels, Germany, France, etc.
   
4. The culture is young and everyone speaks English. You will always find young tourists just like you.
   
5. Optiver's housing is incredible. While the rate at which things get fixed can be problematic, the actual intention of providing the best housing is clear.

Quick information on how to not ruin your laptop
If you come to Amsterdam, you will probably bring a laptop. If you are looking for a laptop, try xpbargains.com

• Computers overheat. And when they don't over heat they are still hot. Please turn off your computer every so often. If you do not have a cooling stand, you are likely to be overheating when you leave your computer on all day and all night. (My rec)
  
• Take out your battery when it is fully charged and your laptop is plugged in. (Tip due to Jerry, thanks Jerry.)
  
• If your computer is in "sleep mode" you can ruin your hard drive by carrying it around. Your hard drive is not turned off so it will spin and is vulnerable to shocks. Putting it instead into hibernate is preferable.
  
• Please look into downloading WinPatrol and AdAware

What happened to the Taylor expansion?
Friends, as soon as I figure out how to put pictures somewhere besides the top of the post, I will be much better armed to discuss the Taylor expansion.

Taylor Expansion

Think fast
Trading is fast. In trading interviews (with the exception of Citadel and Optiver), studying 'higher' mathematics is considered nearly useless. After all, what does a deep thinker have in common with a successful trader? Working on discipline or training your nerves is much more likely to lead to profits than developing a new strategy. What a mathematician may understand with a lot of work, the trader will feel.

The privilege of having a blog is the ability to say whatever I like. Math is incredibly helpful to gain intuition. Math may be more precise than feeling, but it's not the precision that I am emphasizing.

Estimating your wealth
Let's assume the adage that money makes money. In fact, a universal power has decided that your wealth will be given by f(x) = x*x or x squared, where x is your age in years and f(x) is your wealth in euros or dollars. You at 21 years old right now and you are making 42,000 a year. How rich will you be by the time that you are thirty? (please refer to the top picture)

In words
You could assume of course that you will be making 42,000 for the next couple of years. You would be saying, let's discard the higher order effects, like acceleration of salary. Your wealth is where your salary is coming from, where it derives from. Your salary is the first derivative of wealth because it is the first order effect that directly affects your wealth. With this approximation in mind, you can make the first calculation (see second picture). I will make forty two thousand every year for the next nine years so I will make 378,000. That means if I starting with 441,000, my wealth will be 819,000 by the time I am thirty.


In Math
f ' (x) = 42,000 every year (every 1 x that goes by)
f '' (x) = assumed to be 0
f (21) = 441,000
f(30) = f(21) + 9* f ' (21) = 819,000

Damn it
I know what many of you are thinking: 'igor, I want you to make more money since you have such a nice blog. After all, you don't even have any advertising on your site.' I have to go to work to make our next assumptions more probable.

In the next post, I will finish the example and introduce taylor's theorem to help us do the math in a second instead of belaboring the point.

Corporate Meeting and Week Two

If I have a gamma of 10 and a delta of zero, how much money do I make if the stock moves 10 points? (hint : f' is delta and f'' is gamma). I will go into good detail about this in a later post... Answer at the bottom of the post. the Taylor expansion is great for calculating in your head...

Trainee Class
Yesterday, a trainee decided that trading / sales is not for him. He has left the company, but is happy to have made his decision so early. He was a great guy, and by no means unable to get the job done, but this particular work did not suit his more social nature. Though Optiver gets people who study all sorts of subjects, an MBA in management is one of the less likely fields to enjoy sales / trading.

Corporate Meeting
On Tuesday, September 11th Optiver had a river cruise / corporate meeting / dinner. Like all good prop houses, Optiver is secretive about its strategy and market presence. I can say this: the developments, growth, and brand are headed in a positive direction. Offices in Sydney and Amsterdam are in a great position, and the Chicago office sounds like a good place to be.

Company policies are in flux do to the growth. It was hinted that the department might become "more professional." I am not sure if this pertains to the attire of the trading department, but the attire seems to be casual. At this time, it is about 50% business casual and 50% straight up casual.

For chicago trainees: your salary will be paid by the chicago office. It is very easy to set up all the paperwork by contacting the office in Chicago. I suggest doing this before you get to Amsterdam. There is enough to do while you are here. :)

If Training is slow...

1. Technically, you are not allowed to sit with the traders while you are supposed to be studying Natenberg. If you have studied options before, you might have A LOT of extra time. You should think about making friends with the training class ahead of yours and watching them trade. There is a ton to learn on the screen. Even if you understand everything about finance and options, applying that, for example, to the rhythm of scalping or the precision of near arbitrage (buys and sells better than theoretical values [careful, this is not an accepted phrase. I made up this expression]). Watching really helps you get the experience that you need...
2. Optiver has a library of Finance and Options books. Some of these are great, and some are really not that useful... If you have not read Hull, you can pick it up to understand how models approach the problem of finding theoretical values for different kinds of options. All traders should have a feel for why the models are adjusted and in which cases they are sensitive to their inputs / adjustments.
   
3. There is always something to model on the computer, but that can get boring.
   
4. The risk analysis guys are helpful to understand some of the more long term projects in place.
   

Previous food prediction was spot on. I am really finding it difficult to enjoy lunch, which will be great as a trader since I am supposed to "minimize breaks"; slash it will be awesome when I can eat something good in Chicago.

Bring a TI-83 to training. It will save you a ton of time and head aches. Also, daily compounding is impossible on the clunky calculators they let you borrow and you can't ceck your answers if you use simple interest.


Later this week:
-I will also post something that will make your Optiver training easier, the Taylor expansion. Though this isn't covered, many math people know to use it.
-How you could potentially, though I am in no way telling you to do so, download a bunch of finance, trading, options, and math ebooks. Though this is free and awesome, it is illegal for you to do this and for me to imply that you should. That's why you shouldn't, but I will post how anyway.
-If I have time, I would like to discuss the very controversial topic of when you should hedge positions. I will emphasize acceptable risk and bid-ask.
-I really want to think about the concept of dimensonless risk measures in derivatives.

Write me at igor.schmertzler@gmail.com

ans: .5*10*(10)^2=500

1 Week Finished

Why gamma of a call is equal to gamma of a put.


Optiver
From talking with some friends, I have decided that the way Optiver trains its traders is different from the way other firms train. Here are some notable differences:

1. The recruits have a wide range of experience. This makes a big difference in the type of options problems we can solve easily. Finding the formula, plotting curves, and taking derivatives are easy problems for any engineer / mathematically trained person. Explaining intuition, having financial intuition, and financial passion are entirely different. You might say, the second is more important than the first, and you might be right, but then again, you might be wrong.
2. Most young traders hedge their positions before they 1) go home or 2) especially before the weekend. I've noticed it's very easy for traders to get a good night's rest and it's easy to start with a fresh head every day.
3. Recruits come from all over the world (eg. Turkey, India, US, Italy, Netherlands), but the common language spoken in the company is English. It's a big advantage to be a native English speaker because you are able to explain what you understand, read books in English, and communicate what you do not understand.
4. Strong feeling of camaraderie. Unlike the BS that you may get fed at a Goldman type of place, traders really help each other out. The big guys look out for the little guys, and the little guys end up making money for the big guys. It feels great to be encouraged to do what you love to do / are good at.
5. Training is fast! (Actually, I cannot stand how slow the training is, but for engineers / others, this speed is incredible). To learn about Black-Scholes in one day, to understand gamma and vega in the third day, to sum in your head how much you make on gamma if a stock moves, to estimate delta for puts and calls just from looking at some strikes is some pretty serious stuff. All of the recruits did this within their first week!
6. Learning costs money. The trainee's are expected to make many mistakes. Those that do very safe total arbitrage trades all the time are perceived as too risk averse. A good trader isn't afraid of variance when the odds favor him / her (there aren't many her's around).
   

Life in Amsterdam
Amsterdam is a very open place. What strikes me most is how little waste is produced here. First of all, I have never seen a garbage truck. Yet, I never see garbage. People care very little about the type of transportation you use (that is, in terms of fashion). All in all, the feeling is very relaxed. This may be the best place to be in this time of my life.

Mathematics and Finance
For each post from now on, I have decided to have a question or thought about options.

1. If I have 0 delta, 10 gamma, and no other position, how much money do I make if the stock moves by 1 point? How much if it moves by 2 points? Does it matter if the stock goes up or goes down? Why? Can you think of a formula for this?
2. What is an argument for volatility increasing when the stock price falls?
3. Between gamma and vega, which is more sensitive to a)implied vol and b) realized vol

Please email me at igor.schmertzler@gmail.com with your thoughts / charts / graphs etc. I will post the best discussion of every week.

After 2 days of Training

Book
We are using Sheldon Natenberg's Option Volatility and Pricing as our 'bible'. ( This great book and others are listed on http://www.quantfs.com/libr.php )
First Day, Planned
9:30 - Meet with HR to go over company manual and straighten out are residual problems (banking, living, paperwork, etc.)
10:30 - Meet first Trading Mentor, get two assignments that go over definitions (do you know what an option is, what about what a butterfly is?)
12:00 - Eat Lunch
13:00 - Solutions to previous, Get next assignment (Expiration Graphs - 47 problems!)
15:30 - Solutions to previous, Get next assignment (Put call parity and Conversions / Reversals)
17:30 - Solutions to previous

First Day, Actual
8:05 - I was lucky enough to make friends with some traders in the class 2 months ahead of my trainee class, so I walked to work with them. The entire trip took about 20 minutes.
8:25 - Breakfast
8:43 - Show up for the 8:45 morning meeting
8:55 - Set up the desk. Traders get situated, finish up eating, enter adjustments into there models, anticipating the 9:00 am opening. Since it was labor day in the US, the markets were very quiet.
9:35 to 9:40 - No one is upstairs yet, when I go to check.
9:50 - Everyone is waiting for me to arrive, but its not a big deal because the trainee risk manager and trainee wholesale traders haven't arrived yet either. (Our trainee class is 10 people, even though Optiver tries to keep the trainee class at a max size of 6 people). We spend some time going over manual.
10:15 - We have nothing to do so we talk to each other and offer to play some cards.
10:30 - We get the first assignment. It takes about 30 minutes to complete.
11:00 - I sit with my friend and watch him trade for 45 minutes. I am relatively fluent with option theory, but its very hard to understand what is happening on the screen. Simple concepts like risk neutralization are easy to follow though (eg. If I am long delta and short vega, what can I buy to neutralize?)
12:00 - Lunch, officially costs 2 euro in the top floor of the building. The convenience is too incredible to pass up and the food is relatively delicious. However, I am told that the selection rarely changes so many traders get sick of the food and choose to just trade through lunch. I am not in the computer system since I am not an Amsterdam employee, so I have to sign a paper to indicate I have taken a lunch.
2:00 - We get solutions to the first set and start working on the second set.
3:30 - I am still feverishly working the expiration graphs (since there are 47 of them, but our trainer ask if we are finished. No one is finished)
5:30 - The trainer gives us solutions to the expiration graphs. Only the risk manager has finished them, and he has worked as a trader for the last six years. I am able to leave only 6 unfinished.
6:00 - We leave and I walk home with the traders that I watched trade in the morning. My anxiousness to get on the desk is very strong.
After dinner, I go over the solutions to the expiration graphs and read Chapter 11 in Natenberg because we are told to know put call parity and option arbitrage inside and out for the next day. Between that and skyping, I read myself asleep.

Second day
8:20 - We take the tram to work.
8:41 - Breakfast
8:44 - Walk into the morning meeting. Today, all the trainees were supposed to arrive before the start of the meeting but only three showed up on time.
8:55 - We get torn up for missing the morning meeting. Some people are still not at work. Everyone is told to get to work by 8:30. Optiver is running a tight ship here. (please e-mail me if tight ship is not an actual colloquialism)
9:00 - We quickly go over an example of an expiration graph and move onto Put call parity. Put call parity questions (15 questions, eg. give me the theoretical put value for stock = 61, call 60 @ 5, interest rate 5%, 6 months)
12:00 - Lunch
12:30 - Solutions and next assignment. Reversals and conversions for 17 questions with three parts per question (a. trade reversal or conversion, b. how much is the arbitrage, c. what is the implied interest?)
2:50 - Watch the traders trade and ask a couple of question about what different multiples mean on the screen.
3:30 - Solutions, and next assignment. Calculate conversion / reversal for 40 cases then add cost of dividends. Another conversion / reversal page...
4:30 - Discussion on how to treat dividends since discounting them on the conversions / reversals takes forever and doesn't change the answer much.
5:15 - Watch the traders make bank. Volume is spiking in anticipation of the US markets opening.
5:30 - Solutions to everything.
5:45 to 6:15 : We go over some more options theory like intrinsic value and time value. We are a full day behind in the training, so we will have to pick up the pace. For those that have never seen options, they are struggling considerably to keep up even though we are going 'very slowly'

I am pretty exhausted.

Trainee Quality
I am incredibly impressed with the quality of candidates in my training class. Everyone except for perhaps one person is maintaining very high consistency of correct answers and working quickly in a subject where they don't have much experience. It is a humbling experience to work with these guys.

Apartment Tour 2/2

The first picture is the view of the room coming in. Probably the most noticeable part of the room is how high the ceilings are. Since I am much smaller than the average height of a Dutch male, 5' 8" vs ~6'. (see link at the end). This is in pretty serious contrast to the room in the basement, which has ceilings at 2/3 the height. A nice plant (the small green thing in the center of the first picture) from IKEA makes me feel as if I have decorated the place. The second picture shows the incredible closet space. This room would suit a couple comfortably.

In the third picture, take a look at the size of the bed. It's big; it's low; and it is comfortable. The lowness of the bed (compared to American standards) further accentuates the openness. Behind the bed is my computer desk. Thanks to my parents, we were able to get this desk and chair from IKEA. The desk is a mere 45 euro and the chair is about 25 euro. This is where my outlet converter does quadruple-plus duty hooked into my surge protector. The desk lamp and the bed lamp are not necessary since the room is very well lit, but they have proved useful nonetheless. (Training is much faster / harder than I anticipated, but more on that in the next post)

The truly amazing part is how my room is connected to my own patio outside. Take a look at the double curtains opening to the double doors. For those that don't mind people in there room, this is a great place to host a small get-together. When the weather is nice, it's also incredibly relaxing to have your desk open to the outside.

For Prospective Optiver Traders: A note about living conditions
If you are an recruit for the offices not in Amsterdam, you get the three months of living provided. If you are working for the Amsterdam office, you get two months provided. So what happens if you do not like the place in which you are living? Ans: Optiver will pay for your living expenses if you choose to live someplace else. They will also help you relocate with the relocation allowance you are given. This policy usually carries over the two months a trader gets in his city of assignment, but you should check with each office. As of September 2007, the Chicago office allows it. Even if you love your apartment, you may be able to get an apartment leased with a friend and not lose the two months of free living.

References:
Dutch height: (http://www.channels.nl/knowledge/25041.html), (http://en.wikipedia.org/wiki/Human_height)