Interview with Euan Sinclair

I have been a big fan of options trader and author Euan Sinclair for a long time. I have cited his highly readable and influential book Option Trading in my own work, and it is always within easy reach from my desk. His more recent book Volatility Trading is another must-read. I ran into him at the Chicago Trading Show a few months ago where he was a panelist on volatility trading, and he graciously agreed to be interviewed by me.

What is your educational background, and how did you start your trading career?

I got a Ph.D. in theoretical physics, studying the transition from quantum to classical mechanics. I always had intended to become a professor but the idea became less appealing once I saw what they did all day. At this time Nick Leeson was making news by blowing up Barings Bank and I thought I could do that. I mean trade derivatives not blowing up a bank (although I could probably manage that as well).

Do you recommend a new graduate with a similar educational background as yours to pursue finance or trading as a career today?

I don't think I would for a few reasons.

The world of derivatives and trading in general is now so much more visible than it was and there are now far better ways to prepare. When I started, physics Ph.D.s were hired only because they were smart and numerate and could pick things up on their own. My first trading firm had no training program. You just had to figure stuff out on your own. Now there are many good MFE courses or you could do a financial economics Ph.D.

Further, it would very much depend on exactly what kind of physics had been studied. I did a lot of classical mechanics which is really geometry. This kind of "pure" theory isn't nearly as useful as a background heavy with stats or simulation.

I think I could still make the transition, but it is no longer close to the ideal background.

You have been a well-known options trader with a long track record: what do you think is the biggest obstacle to success for a retail options trader?

Trading costs. Most option trading ideas are still built on the Black-Scholes-Merton framework and the idea of dynamic hedging (albeit heavily modified). Most pro firms have stat arb like execution methods to reduce the effective bid-ask they pay in the underlying. They also pay practically no ticket charges and probably get rebates. Even then, their average profit per option trade is very small and has been steadily decreasing.

Further, a lot of positional option trading relies on a large universe of possible trades to consider. This means a trader needs good scanning software to find trades, and a decent risk system because she will tend to have hundreds of positions on at one time. This is all expensive as well. 

Retail traders can't play this game at all. They have to look for situations that require little or no rebalancing and that can be limited to a much smaller universe. I would recommend the VIX complex or equity earnings events.

As an options trader, do you tend to short or long volatility?

I am short about 95% of the time, but about 35% of my profits come from the long trades.

Do you find it possible to fully automate options trading in the same way as that stocks, futures, and FX trading have been automated?

I see no reason why not. 

You have recently started a new website called FactorWave.com. Can you tell us about it? What prompted the transition of your focus from options to stocks?

FactorWave is a set of stock and portfolio tools that do analysis in terms of factors such as value, size, quality and momentum. There is a lot of research by both academics and investors that shows that these (and other) factors can give market beating returns and lower volatility.

I've been interested in stocks for a long time. Most of my option experience has been with stock options and some of my best research was on how these factors affected volatility trading returns.Also, equity markets are a great place to build wealth over the long term. They are a far more suitable vehicle for retirement planning than options!

I actually think the distinction between trading and investing is fairly meaningless. The only difference seems to be the time scale and this is very dependent on the person involved as well, with long-term meaning anything form months to inter-generational. All I've ever done as a trader is to look for meaningful edges and I found a lot of these in options. But I've never found anything as persistent as the stock factors. There is over a hundred years of statistical evidence, studies in many countries and economic and behavioral reasons for their existence. They present some of the best edges I have ever found. That should be appealing to any trader or investor.

Thank you! These are really valuable insights.

====

My Upcoming Workshop

October 28-29: Quantitative Momentum Strategies. 

Momentum strategies have performed superbly in the recent market turmoil, since they are long volatility. This course will cover momentum strategies on a variety of asset classes and with a range of trading horizons.

====

QTS Partners, L.P. has a net return of 1.25% in August (YTD: 10.44%).

====

Reader Burak B. has converted some of the Matlab codes from my book Algorithmic Trading into Python codes and made them open-source: https://github.com/burakbayramli/quant_at.

====

Follow me on Twitter: @chanep