Friday, April 20, 2012

Many ways to

In reflection of being on the trading floor, the biggest benefit was observing the diversity of strategies everyone used and the niches they settled into. Charlie D said that the best way to learn how to trade was simply be a good copycat and to start that's something I definitely did by watching a lot of traders and asking a lot of questions.

Gonna get a little sidetracked until getting back to the point of the story...

Before joining a small trading group I rotated on various order desks at an institutional brokerage for nine months in 1999 and spent a fair amount of time at their CBOT Dow desk which was run by a very aggressive broker who I think is still on the floor there.  The desk broker trained me on how to be a great desk clerk to the point of being able to handle three phones simultaneously (four is impossible) of two index arbs and a market maker at the AMEX.  Anticipating the index arbs was a simple but mind numbing exercise by watching the fast cash bid/ask of the index 'basket' to know what the arbs would be looking to do as the phone rang, i.e. the futures were trading at a slight discount to where the index components were bid in the stock market, taking into acct where fair value was calculated (which slightly varied by firm).  Little things like good anticipation on the desk clerk/broker was basically the difference on if the arbitrage was successful or not as other desks were hitting the market the same way at the same moment. 

Anyways back to the there were a couple locals in front of our desk who were doing Dow/S&P arbitrage and it just completely blew my mind that such a thing was possible how they did it.  Basically they were trading the relative value of the futures against each other in terms of how under/over valued they were to the respective fair value.  At the time I think the ratio was something like 7 Dow to 2 or 3 S&Ps and they'd make a few trades each day just waiting for one index to get over/under valued relative to the fair value of the other.  Granted this was 1999/2000 so there was good volatility but just goes to illustrate one of the many ways to skin a cat I observed on the floor.  I can't imagine this continuing to be a viable strategy anymore which is why it's ok to blog about. 

One of the biggest market making firms had a lawsuit against some former employees which outlined a similar approach in the same pit and it all reiterates the first thing a trader told me when I got to Chicago, "the amateur looks for the greatest reward and the professional looks for the least amount of risk."
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