Saturday, October 16, 2010
An Insider Chat With World Renowned Option Expert Charles Cottle
Dave: Let's start off by getting a bit of history about yourself. I know you have had tons of experience in and around the option markets. What first got you interested in options?
Charles: I was an accountant. I use to track the transactions of my clients and I got very interested in the workings of options. I then had the opportunity to visit a friend who was trading on the floor. This was an amazing new world that I never even knew existed, even though my office was just down the street for years. I worked at a family accounting firm during the summers. At this point, I was a year out of college and I visited the floor. Several of my friends were starting to trade futures. Futures did not attract me, but options seemed intriguing. It seemed like you really could control the risk. I went to a free seminar and came back to the office and said "I'm giving a years notice to this family business of 65 years." Then I went down to become a trader.
Dave: Wow, that took some nerve leaving the security of the family office. We are talking about Chicago and the CBOE?
Dave: What was your evolution on the floor? Did you start out as a clerk or did you step right into trading?
Charles: I stepped right into trading. I read a few books and figured I didn't have to go that route. The market told me differently, because 6 months later I lost all my money. I just didn't understand things. I thought when the customers were buying I could just take the other side and bet against them. I had no idea on how to take on an inventory of options. The other guys in the pits seemed to be so emotionless about every single trade they made. I was riding on every single contract that I had. I was basically hoping, praying and doing all the wrong things.
Dave: What was the path between being a losing trader and the thinkorswim brokerage launch?
Charles: There was a lot of in between. I went back to trading and I was a clerk for a while. I latched onto a fellow who was leaving his job. He was a Spread Hunter for some market makers on the floor. He wanted to become a market maker and needed to replace himself. I got the nod that he would train me. This is about the time that I was offered a job by someone who would eventually back the owners of thinkorswim. I turned that down because I was on a mission to learn everything that there was to know about options. I let Tom Sosnoff get the job, he now runs thinkorswim. We have had a very long friendship. At that point I went down to the Board of Trade to trade. I traded for many years and then Tony Saliba started The International Trading Institute and I wanted to take a breather in the late 80s, I decided to gallivant around Europe and when the new electronic exchanges were sprouting up, I started teaching market making in Europe. I wrote all the course material for The International Trading Institute and delivered all the content to the banks in Germany, Spain, Austria, and Denmark. That was about a five year tour of duty for me. Two of the years were in Europe, then I was in Madrid for four or five months, spent four or five months in Sweden and just had wonderful time. I learned a lot about electronic trading.
Dave: Is that the impetus for your book, Options---Perception and Deception and Coulda Woulda, Shoulda? Which by the way, I consider the best options book ever written.
Charles: Thank you. Yes, and for thinkorswim. I dreamt up the concept of thinkorswim after that whole journey, Tom came up with the name. I called Tom with the idea after waiting to hear from companies like E*Trade concerning my concept. Tom said, "Hey we can do that." But he was not anxious to build spreading into the platform. I insisted to build the spreading technology if he wanted me to come on board. I still have the email from 1999,about a year before we even started the business, saying "Though I am inclined to believe and agree with you that spreading is the way to go, the CBOE is going to have their one-year anniversary for the last time they had a spread. They are going to have that party next week."
Dave: I hope he was joking. Tom can be a character!
Charles: Yes, It was a funny joke. However, I insisted and he said that we would build it. When we built it, we had built it before even I could accept an order. So the day they opened their doors electronically, we were firing spreads into the exchange! Today about 90% of thinkorswim business is spread orders.
Dave: Earlier you mentioned the term, Spread Hunter, can you explain to our members what this is?
Charles: Well, before all these computers that had software that scans the market to hunt down certain spread criteria, we had to manually pull them up to see if there were any good spreads in the market.
Dave: So you were actually looking for spreads to put on, not searching for existing spreads to knock out.
Dave: Many traders are scared of options, do you have any words of advice to someone just starting in options and learning the options language?
Charles: I agree with you. It is a scary thing, especially if someone doesn't learn it properly. That is why in the first paragraph of both of my books it says, "Stay away from options." Then in the second paragraph it says, "Oh, you are still here? You better educate yourself because there are a lot of things that can blindside you." In my book there is more about losing money than there is about making money. The way that I go about teaching it is by a market makers standpoint. I found through revamping Options: Perception and Deception was a book for market makers into a retail product that we gave as the Think or Swim guide to options which is now available for download atwww.riskdoctor.com at no cost. If you jump right into the last chapter of it, which in the new version is the first chapter, you will see an email dialogue for two months with somebody. A lot of the jargon and nomenclature addressed there in the normal conversation of email back and forth as I help this fellow manage his first electronic trade. To support that, the first chapter is called "Picking Up Where The Rest Leave Off: Synthetics." It dives right into using synTools and boxTools. These synthetics are where the market makers can turn around the way they look at the position and understand it a whole lot better. For example, one of the first examples in the book is the covered write which is a very popular thing. You ask the same person who is excited about doing covered writes, "Would you sell naked puts?" The answer is 'No.' But you can prove to them, using these market-maker tools that I have assembled that have been used on the floor for decades, they see that it is exactly the same thing as a short put, penny for penny.
Dave: What exactly do you mean when you say 'synthetic?'
Charles: Well, it's something that is equivalent to something else. You have a package of two different items that emulate or impersonate another one. For example, a long stock and a short call behave the same way as a short put. So if you have the long stock and the short call, and I had a short put, you and I would have the same future. We would have the same profit and loss outcome.
Dave: You are creating something by combining two or more things, mirroring the result. Am I understanding?
Charles: Yes, that is exactly right.
Dave: Let's go a little deeper and look at several different market conditions and discuss which option strategy would work best for each condition.
Charles: That is the idea behind thinkorswim. The idea where you had to teach people about spreading because back then in the late 90s and early 2000, in that era, premiums were so high that you can only sell premium if you wanted to make money. But selling naked premium was prohibited from a risk and margin standpoint. The only thing else was to buy the option. Well, buying the option was prohibitive because it was too costly. So what's left, Spreading. Limited risk, short premium is a very good way to consistently make money, but you have to have in your arsenal of tools that are able to take advantage of any market. Buying long premium, one usually has to be really right. It's probably best to use a vertical in most situations.
Dave: Long premium is just betting on the stock going up with a call?
Charles: Well, that is one way, but you can also buy put premium. You can also buy straddle or strangle premium which is buying for both directions. You are buying a call and a put so you can take advantage of a move in either direction.
Dave: Many people reading may not know what you mean by 'vertical.' Please explain what you mean by this term.
Charles: Sure. A vertical is an option position composed of either all calls or all puts with long options and short options at two different strikes. The options are all on the same stock and of the same expiration, with the quantity of long options and quantity of short options netting to zero.
Dave: Would one use a vertical if they are bullish--or bearish on the stock?
Charles: Both. There are long call verticals.
Posted by marketsurfer at 12:08 PM