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A web-reading bot made millions on the options market (slate.com)
200 points by prostoalex on Apr 26, 2015 | hide | past | web | favorite | 129 comments



'It also feels pretty far from the theoretical purpose of options trading. Options are meant to provide insurance (a “hedge”) against potential losses in a stock position. Market makers like my friend create the environment in which to buy the insurance. This bot instead treats that market like a roulette wheel—except it knows exactly where the ball will land. “If someone else has what we call the ‘future script,’ ” says my friend, referring to the crystal ball of the algorithm bot, “it really feels like they’re just robbing you."'

Robbing who? This is about as far from robbing as I can think of.

1. Someone offers to sell a bunch of options, because he thinks he'll make more money from this than if he didn't sell those options.

2. Someone buys these options because he think he'll make more money than if the didn't buy them.

3. Time reveals the guy who bought the options was right, and he makes money.

This is simple speculation, and has nothing to do with robbing.


It's only "robbing" when you're losing money instead of making money - which a lot of these crazy made up systems (options, etc) can't help but do most of the time. They're just complaining about evolution :)


Anybody that thinks the primary purpose of the options market is "insurance" is ignoring their history. Among other things, calls were introduced 4 years before puts. They are derivatives. They serve many purposes.


What purposes exactly?

If you'd ask me those derivative products are a convenient alternative to casino style gambling and mostly add instability to the market.

I would love to hear an informed opinion, though. What do these products solve, why are they essential? Also, what would happen if we would tax them more heavily, perhaps incrementally over a period of time?


Options and many other derivatives are not merely a casino game. Their unique role as financial instruments is to allow the transfer of risk from those who have risk and don't want it (hedgers) to those who don't have any risk and do want it (speculators). This is different from gambling because gambling by definition involves the creation of entirely new risk for the purpose of wagering; derivatives transfer pre-existing risk that will continue to exist anyway even if the derivative didn't exist. This is identical to the more familiar role of an insurance company in everyday life.

For example, suppose someone has a long term stock portfolio -- a classic fundamentals investor with a decades-long time horizon, the farthest thing from a casino style gambler you can find in the stock market. Maybe it's a pension fund or an institutional endowment. They very much do not want to take highly risky short term bets. They are only interested in safe, slow, long term returns.

But markets can only provide that in aggregate. In the short term, markets are very unstable, and individual stocks go to 0 if the company folds. The long-term investor thus constructs a portfolio of many small investments rather than a few big ones.

The portfolio manager has reason to believe that XYZ, one of the portfolio companies, is about to go bankrupt. This is not certain, but the stock has already begun to drop. If the stock drops to 0, the portfolio stands to lose a lot of money (despite continuing to exist overall because of diversification.)

The portfolio manager can buy put options to hedge XYZ. These give the holder the right to sell XYZ stock at a certain price, regardless of its current market price.

In this case, they function as a form of insurance. If the rumors are false, XYZ stock will bounce back up and the put expires worthless. If the rumors are true, XYZ drops to 0, but the portfolio manager can still sell his XYZ stock to the speculator who sold him the put option at a pre-determined price.

This is no different from buying fire or flood insurance on your house -- if the value of your house goes to 0 through disaster, you can in essence sell that worthless house to the insurance company for a predetermined price and buy another house. Options are the stock market version of that.

If you tax them more heavily, that will make them more expensive to use, which will discourage people from using them and arguably increase instability while decreasing growth in the stock market as everyone will be forced to carry the full value of any losses themselves, with less possibility for insurance.


That's a great explanation, thanks!

However, I still don't see the necessity of these instruments.

For example, wouldn't it be more natural for a pension fund to just spread the risks by buying different stocks?

Also, I'm not convinced that derivatives would decrease instability. Like I said, I would guess they do the opposite.

Perhaps there is some theory that can show this (something akin to e.g. the fact that passive systems are always stable, for some definition of "passive"). Or perhaps there exist empirical simulation-models that can shed a light on this?


Options are sometimes more liquid than the underlying stocks, allowing you to hedge when you wouldn't be able to directly. Consider a case where you want to short a particular stock. Shorting a stock requires borrowing it first, but some stocks may simply not have many people willing to lend. Often you can still get puts on hard-to-borrow instruments to hedge your position. There will be a premium for that insurance, but it may be worth it depending on your position.

Options also allow you to bet on more specific stock movements. Maybe there's a merger rumor and you think the stock will either go up (merger goes through) or down (merger fails). You couldn't make that bet with a static position on the underlying, but you could buy a put and a call (straddle).


Imagine you have a very diversified portfolio of stocks. You are concerned with a very real possibility of a big market drop. Sure, you could start selling off stocks from your portfolio, incurring various transaction fees, capital gains taxes, plus you know have to reoptimize your portfolio on the fly because since you sold off some stocks, it's now probably out of balance. Or, you could just buy puts on S&P 500 and you don't have to deal with any of those issues. It's much more convenient and efficient to do that. It's really the same thing as going to a supermarket and seeing a wide variety of products instead of just bread, meat and apples. Is it a must have? no. Is it useful, though? yes


> However, I still don't see the necessity of these instruments. > For example, wouldn't it be more natural for a pension fund to just spread the risks by buying different stocks?

That's like saying, "Wouldn't it be more natural for a homeowner to just spread the risk of fire by buying multiple houses?"

Yes, in theory you could buy 2 houses and just move into the 2nd house if the first one burns down... but it's much more cost efficient to buy one house and get insurance on it. You'd have to buy 2 inferior houses instead of putting all of your money into 1 nicer house and paying a small amount for insurance.

There are lots of theories and studies on the topic of stability, though it is very hard to draw firm conclusions as the economic and financial conditions at any given moment are unique, making repeatable experiments difficult or impossible.

Another complicating factor is that you can make lots of money by discovering a way to make market systems more stable that nobody else knows about, so much of the research on the topic is secret.


I think the real answer is that things don't need to be necessary to exist. Options are just another way to structure investment. They exist because someone decided to create them, and they continue to exist because humans don't like losing things they already have.


Well, for that matter, stocks don't need to exist, either. We could go back to the medieval way of requiring all business enterprises to be fully funded by the founders personally. The problem is that greatly restricts the scope of what kinds of businesses can exist, since most interesting things for a business to do require a lot more capital than most people have or can raise.

There are many examples of failed derivatives instruments -- that is, derivatives instruments that once existed and no longer exist today because of lack of interest in using them. They performed an insufficiently useful economic role, so nobody traded them. Today, for example, there is an ongoing effort to list real estate futures, but there is little marketplace interest and they will probably be delisted within the next few years.

The derivatives that survived survive not from mere inertia, but because people (not some abstract "system," but real people) find them economically beneficial in some way.


One purpose: leverage


I can see why it could be viewed as robbing. The person selling options assumes there is no information asymmetry. The bots that do this aren't betting, they have new information that shows that the current options price doesn't reflect yet.

I wouldn't say this is necessarily a bad thing myself just pointing out this is definitely not the spirit of what options are for.


But the information is public -- anyone can read the tweet as soon as it comes out, a computer just happens to do it a lot faster and better than a human.


Exactly and since bots are allowed to buy options, the seller shouldn't assume that only humans would be buying their options.


That's why I'm not saying it's "wrong" but it also is no longer making a bet on randomness.


"The trade occurred 19 seconds before the tweet, and one second after a headline appeared on the Dow Jones Newswire."

I don't understand the mystery here. It would be trivial to write a bot that could interpret a headline and make a trade on it in under a second, and that's without any special high-speed links. With API documentation for a brokerage house, I could write such a bot in probably half a day. Given the astronomical sums of money involved, I have a hard time believing that this isn't occurring on a daily basis.


Agreed. I don't really understand the surprise in article and wince at the "My friend reckons....." style.

This is indeed occurring on a daily basis. A number of funds trade automatically based on fully automated analysis of the news wire and other sources.

I believe most use in house analytics but there are 3rd party solutions:

http://www.ravenpack.com/

I think people outside the industry don't appreciate the depth and breath of automatic trading that is going on. Understandable given that it's in the interest of insiders to stay out of the spotlight, and the public mostly only sees the HFT headlines.


Yeah you remember a few weeks ago the Tesla stock moved $2 when Tesla announced its april fools new product? That was completely automated.

It may not even have had to discern a new product announcement or launch. It may have just looked at twitter volume mentioning Tesla which doubled that day, and did sentiment analysis (much easier, which showed the communication that day was very positive), and purchased a bit of stock based on that. Who knows.


The irony is that likely those bots actually did make money. It's the other bots that later "jumped on the bandwagon" (and perhaps a couple humans) that probably lost big.


Oh yup, how come they're an analytics provider and not a fund? ;-p


I don't know anything about the provider in question, but funds might integrate multiple data sources (e.g. the described tweet analysis, last financial results, competing companies) - in other words, a lot more than what an analytics provider needs to do.

Maybe the analytics provider wants to focus on doing one thing and (hopefully) doing it well?


The point is that any time you see a trading tool being offered publicly you can reasonably assume that it's actual usefulness is pretty limited, at least by itself. Otherwise, they'd be using it internally to trade and make more money.


Probably because you've never bet a lot of money on natural language processing before. Backtest and check alpha. cpercival's idea is pretty good though. I'm reminded of: https://xkcd.com/793/


The headline of that news was "Intel in Talks to Buy Altera". You are acting like it would be difficult to write software that would be able to figure out what that means. It's not. These headlines also seem to follow a very specific pattern [1].

So if WSJ has a headline that X is in talks to buy Y, that's pretty much that. Also you could eliminate most of your risk by placing a limit order based upon the last trade prior to the news coming out. The market will either a) confirm that you are one of the first people to understand what has happened by filling your order at a price that doesn't reflect the news, locking in profits, or b) your limit order won't be filled because the price already is already above your limit, in which case you have assumed no risk.

[1] https://www.google.com/#q=site:wsj.com+%22in+talks+to+buy%22


It would be easy to write software to parse that particular phrasing of that particular relationship ("Company X in Talks to Buy Company Y"), but to catch any arbitrary relationship between two entities in a given domain? That's no longer an easy problem. Not to mention that you'll need to represent that world knowledge coherently in ontologies / knowledge bases and write complex logic around it to make the data actionable.


All you need is a positive correlation between an action taken on a weighted evaluation of a headline containing key words, and profit. You're overestimating the difficulty of the problem. It's model training; there's lots of historical data to tune on.


> It's model training; there's lots of historical data to tune on.

Is there a timestamped archive of DowJones Newswire articles? I found it difficult to find archived news articles the last time I was looking for them.


Sentiment analysis has plenty of research around it, and once you've got a big enough training and validation set, it can give very good results. My old boss works for a company that runs sentiment analysis on comments made about companies to automatically highlight positive/negative messages - it's not a massive leap from there to repurpose that to analyse positive or negative news reports about a company.


let us know how it works out, then. :)


These bots don't actually do much analysis. They just weight keywords and sources. "Buys" or "acquisition" in a WSJ headline has a pretty clear cut meaning. Financial headlines also tend to be pretty easy to parse (e.g. "X Buys Y").


Do you think "buys" would be less lucrative than "in talks to buy"? I imagine by the time company A buys company B, there has already been rumor and the markets have already moved to reflect that speculation.


Most financial news feeds are distributed in a standard format. [1]

https://iptc.org/standards/


Automatic trading is an automatic occurrence in deed, and many bots are design to respond to news, tweets, and all kinds of things. That said, if you really think you can write a bot that can do really good in the market, why not just make one. For the sake of argument, just assume that you can confirm a trade in 1-5 seconds, make a bot that just does fake trades, give it $10k in fake currency, and let it play.

Come to think about it, such a system, with an API, would be really nice to have. Something that allows anyone to create a trading bot and see how it performs. Any one what to make one? :)


Those systems exist, Metatrader, TradeStation, NinjaTrader, and people do exactly that and have been for years.


These APIs exist, and many of them allow two cool things:

1) Virtual money. So you can try out your bot and see how it'd do without risking money. (with $10k on say the Forex market which trades about 5 trillion per day, it doesn't matter if your trades are virtual)

2) Backlogging. So you can write a bot that'll analyse prices, volume, the orderbook etc of any moment in the past 6 months, which allows you to immediately simulate your bot's success in that market over a long period of time. (of course this is if you want to write a bot that analyses the exchange data, as opposed to things like news, for which you'll need to find your own database going back 6 months which isn't too hard btw, but a lot of data to process quickly).


I imagine there would be pretty good money in licensing an API. That's probably where the real money is--let the idiots make the trades, and you sell them the software.


Yep, it's like the someone else said in one of the other comments, don't dig for gold, sell buckets and the shovels to those who do. :)


Always heard that as "In a gold rush, be the one selling pickaxes"


Well, if everybody started doing it, won't the returns fall to zero? Sort of like if arbitrage opportunities are present (in this case its a technological one), this would go away.

I bet since writing this article the opportunities has pretty much slipped. Now anyone living close to the exchanges will do this.


What if many people are not doing it because they think that many people are already doing it, and actually as a result of this, very few people are doing it?


they would lose money and only to be replaced by others who think the same thing?


My bet is insider trading with someone writing a simple bot to make the trade once they see the trigger words made public.


That was my first thought too. Since sometimes these are sub-second trades, it'd be interesting to look at whether they're physically possible (i.e. whether speed of light is respected.) Would explain stuff like [0].

[0]: http://www.washingtonpost.com/blogs/wonkblog/wp/2013/09/24/t...


Well if it doesn't respect the speed of light then they didn't wait for it to become public. What your parent was inferring was waiting for the news to actually hit the wire so it does look legitimate.


It's no longer insider trading if the information has been made public. There would be no advantage to doing this either. There are thousands of firms and individuals running keyword based trading bots. You would be competing with all of them.


You may be much better educated than I on insider trading, but as I understand it courts have ruled that insiders have to wait a reasonable amount of time for the public to absorb that information. "Reasonable amount" seems to have changed over the years (first read about it in Business Adventures, Buffet and Gates' favorite biz book), but I note that most trading firms today state you must wait until the 3rd business day to act on that information.

Another issue is whether you know this is fact, but the public only knows it as rumor.

Of course, you'll want to consult a lawyer about all this.


>wait until the 3rd business day to act on that information?

Definitely no. Just watch the news and see that the stock price of any company changes after pretty much any news.


That's because of the NON-insiders trading.


Sorry, I didn't catch that part. I thought the commenter was referring to anyone.


It is insider trading, if you use the insider information to write a very simple tweet parsing rule instead of having to write a complicated AI algorithm to parse this information before any prior knowledge.

Also, if I understood the article correctly, this trade involved to transactions: first, purchasing the options, and then, purchasing actual stock using those options. And (once again, correct me if I'm wrong), the options themselves were purchased before the information was made public, so this transaction may have been the direct result of insider information.


> And (once again, correct me if I'm wrong), the options themselves were purchased before the information was made public

No, according to the article, the options were purchased one second after the information first became public in some news wire headline. The fact that it was also 19 second before a journalist's tweet was apparently irrelevant, since there was that headline before the tweet.


It seems to me that the information leading to the journo's tweet probably also preceded the news wire headline. I guess it's _possible_ the the tweet we written by somebody who saw the news wire headline as it hit the web, and they read it, understood it's importance, wrote and posted their tweet – all within 19 seconds (not _impossible_), but I'd be curious to know where the information for the news wire post came from. Somebody knew long enough before that headline got onto the web to have time to write it (and the article).


I must have misunderstood. Thanks for correction!


Well, it's still insider trading if these trades were not disclosed by the people who had inside knowledge and did make these trades.

Also, I wonder if it even has to be all that complicated as some kind of computer program monitors keywords. For all we know, it's just a guy sitting in his living room with with 2 Chrome windows opened, continuously refreshing the Dow Jones Newswire, with the trade all setup and ready to go in the other window.


Those competitors would likely have protections built in to filter false rumors---more than one source, some kind of scoring algorithm, etc. An insider wouldn't need any of that since he knows the rumor is true.


It might not be insider trading in a legal sense, but in a moral sense it kinda is.


Then that's not insider trading. The news was made public, your bot just acted on that public knowledge before anyone else could. It's a matter of speed not knowledge.


I've had a go at writing something similar in the past. It was against the Australian news on the ASX. Suffice to say I wasn't successful.

Even with a clear understanding of the situation, the reaction from the market was mild compared to the swings of the global tides. When it worked, it worked well. But you had to have the wind in your back to get decent moves.

If I were in the industry with low cost access, and I were on the US market, I think things might have been different. But in my experience, you don't get rich searching for gold, you get rich selling the buckets and the shovels.


Interestingly, they don't discuss the possibility that someone just has a radically better UI for acting on market gossip.

"“It would be impossible for me to do. By the time you could read the news, process it, and press the ‘buy everything’ button, it would take too long."

I'm picturing the context switch between reading a tweet or news article and some rocket ship of a program which gives you enormous power but takes some time to place a (possibly complex) order.

What if it's just turking with a hotkey? Watch feed, see headline, Ctrl-u.

This feels a lot more plausible to me than the idea that someone made sentiment analysis not suck.


This feels a lot more plausible to me than the idea that someone made sentiment analysis not suck.

If you can respond faster than everybody else, you don't need sentiment analysis. Just bet on volatility increasing (aka. buy options on both sides) whenever a news story appears about a company.


There are many times a news story appears about a company that have absolutely no impact on the stock. In fact, the anticipation of a news story that turns out to be nothing note worthy will lead to a drop in volatility and make your trade a losing one.

See every time a company announces earnings in line with expectations for example. "x company made 1 billion in profit" could fail to move the stock at all.

Betting that news is market moving requires a decent amount of analysis of the news and the credibility of its source.


You could do some very simple keyword analysis to filter that out, though. When words like "the deal", "in talks to buy", "to acquire", etc. appear, it's a pretty good bet that it has something to do with an acquisition, and also a good bet that volatility will spike.

A lot of people here are saying "I wouldn't bet $2.4M on that false positive rate", but that's not how traders think. You only have to be right more often than you're wrong (or alternatively, very right to offset being wrong a lot more often) - "betting" is exactly what they do for a living. It's pretty much the perfect application for statistical machine learning - users never see how bad your algorithms are, and so it doesn't matter if the quality is worse than a human as long as the speed is better.


"the deal"... Is still being negotiated Company x has been looking "to acquire" a player in field y for some time and hasn't found any candidates yet.

Keyword analysis by itself is almost completely useless.


Since when do newspapers write about the lack of something happening? That's sort of anti-news, isn't it? I could potentially see them writing something like that as a throwaway sentence in another article about the company, but the phrasing you've quoted is incredibly awkward and would probably never make it into a real news story.

Also, an algorithm doesn't have to be perfect, it merely has to be right more often than it's wrong. So what if you get a few false positives and a couple of your trades blow up? That's why you're managing a portfolio and not dumping your entire assets into a single trade.


When it comes to market speculation, non-news is published quite frequently. Often time it comes in the form of stories that summarize what happened that week.


Betting that news is market moving requires a decent amount of analysis of the news and the credibility of its source.

You don't need to be right every time in order to make a profit in the long run.


You missed the point I was making about news releases causing a drop in volatility when it confirms expectations.


As long as news releases usually increase volatility, you're fine.


Right, I would argue that for many companies it doesn't though. Look at how many news articles mention aapl every day and it has no measurable impact on the volatility. You also have to be careful not to get wiped out by macro volatility which tends to move around a lot more than individual stock vols.


I agree with you (that's a great idea), but if you're going to bet 100k+ you could afford humans in the loop. I guess you could tell the difference by looking at what options get bought.


Being able to afford the money which humans cost is easy. Being able to afford the time which humans cost is not so easy. The optimal strategy might be to trade within a few microseconds based on "something happened to this company, so something is likely to happen to its stock price", then trade a bit more a few milliseconds later based on "a computer thinks that this sounds like good news", and then make a third trade a few seconds later based on "a human pushed the (green|red) button when they saw the headline".


Given the description I would probably have the program queue up what it would buy based on the story and push the 'go' button. Except I believe the reason the options trader doesn't believe that is happening is that to do this you would just be sitting there watching all the possible 'go' buttons go by and clicking only the "right" one.


Have a fast NLP engine looking at the queue, and when it spits out a >80% certainty for a buy or sell action flash the news item up on the screen with a green or red background accordingly. Double-click to confirm, order only goes out if the reaction is quick enough to make it worthwhile. You could even flash it up on several traders' screens and do it by majority vote.


Makes sense -- kind of a market "upvote". I could actually see that UI working. The great thing about reacting to rumours is that you can profit off everyone else who skim reads and clicks "buy". So often the initial impression is good enough.


What's probably happening is they have a "bot" that does the sentiment analysis, readies the trade, then pops a big message up in front of the trader:

New WSJ Headline: Intel in Talks to Buy Altera

ALTR Stock: Trading within 30-day range

{ALTR 30-day stock graph}

March 2015 Call Options available

..and a live-updating, clickable GUI displaying, in a linear manner (i.e. low risk, small bet at one end; high risk, large bet at the other), the call option market depth at each strike price, annotated with the implied volatility and the % delta to the current stock price.

The trader reads the info, decides how much he wants to bet, then clicks the appropriate spot on the GUI to execute the trade.


There's no way that there's a human in the loop. You're talking one second from the newswire hitting the Internet to a trade being executed on the exchange.

More likely, the human prepares a list of scenarios of the form of "If a news story with these keywords appears, it will affect the valuation of this company in this way, perhaps plugging these numbers from the article into some model." News story hits the wire, the program reads it and applies some simple text mining, it compares the current market prices with the expected valuation, and it sends an order to the exchange to execute the trade.

Way back in 2006, I worked at a financial software startup where one of our products (the only one that made money, actually) did exactly this. The company is defunct now - it had a bit too little focus for a small shop of a dozen or so people, and its other products weren't all that succesful - but that was one of the things that actually worked.

If you're trading manually on time-sensitive information these days, you are an idiot. Back in 2006 it was something like 80% of trades on the market are automated bots; the only people who still put a human in the loop are the rubes.


> You're talking one second from the newswire hitting the Internet...

I expect they'd be getting the newswire in real time via Bloomberg or Reuters, instead of off the Internet.


or, an insider, who waits for the first public news to avoid detection.


Interesting idea, just show the gossip, extract the involved companies, and provide buy/see buttons for the companies involved.

Is it possible to also bet directly on whether some piece of gossip is true or not?


A lot of people seem to assume that humans are too slow to react to news, but this is definitely not the case. As an example, when the SNB dropped the swiss franc cap earlier this year (one of the biggest financial news stories for years), I know people who had time to read the headline on Bloomberg, look to see where the market was trading, and sell EURCHF within 0.1cents of where it was previously trading. As I watched the market reaction, I'm fairly confident that the other traders reacting were also human. As it was unscheduled, no-one would've been actively anticipating it happening on that day, never mind that minute.

Generally, there are two types of financial news events. First is scheduled, for example unemployment data - here, there are APIs to get the number and place trades, and as a human it is impossible to compete. Similarly, for FOMC statements, there is an API feed which provides objective answers to certain questions about the statement, e.g. "Did any Fed members vote for a rate increase?" Again, computers dominate. The other type of news events are surprises - unscheduled events that people are unprepared for. I'm certainly no NLP expert, but I do watch financial news feeds every day, and I can't imagine it being remotely easy to write a program to filter out the false positives. I've certainly watched a lot of market reactions to headlines, and I can tell that a lot of headlines that people would assume would be easy to write algorithms to trade on, produce market reactions that look far more "human" than the instantaneous reactions to unemployment data or embargoed Fed statements.


Agreed -- one can configure a Bloomberg terminal for immediate drop-everything news alerts accompanied with pre-filled trade tickets containing positions you currently hold. I'm in no way saying a human did this or that is what happened, but just that the time-to-trade is probably a lot lower for a human than most people think due to better tools (that themselves can even leverage NLP/ML inside). It would be interesting to see someone study just how fast humans can react using these type of alerts.


Next step, make a bot to tweet out (fake) news to trigger this bot and place itself on the winning side of the trade.


This reminds me of the recent Tesla April Fools press release for a new watch called the 'Model W'. Clearly there were bots written to monitor Tesla feeds and other companies for new products and trade automatically as the stock price jumped $2, before returning back to normal by the end of the day.


That's called "pump and dump", and I believe it is illegal.


They can send the bots to jail.


Also, it's very easy to use a whitelist of twitter accounts.


I imagine these bots only follow reputable news sources.


It's also possible that an insider knew the news was about to break and waited for the announcement with the trade queued up.


I don't understand why this is even considered news. Bots have been monitoring and trading on realtime news information for years.


Most people seem to be unaware of this fact, as the comments for this post demonstrate.


This touches on several of the Big Issues with being a market maker, shopping large orders, and HFT. Sadly, it's exactly as detailed as you'd expect a Slate article to be.

It doesn't matter that it is a bot. The controller of the bot happens to be, in this instance, directional order flow: unlike the overwhelming majority of market volume, he actually has an edge.

The options market maker is, unusually for market makers, forced to transact with any comer. They've got a license to print money and that is the price of the license. They get to pick their pricing.

In the old days, when people actually talked, parties would be cagey about whether they were buying or selling, to make sure the market maker didn't use that against them. The conversation went like this:

"Make me a market [quote a buy price and a sell price] for 100 contracts of May Foo CALLs at $15."

"0.10 by 0.15."

"Buy a hundred."

"Done."

"Make me a market."

"0.10 by 0.15."

"Buy a hundred."

"Done. #'(%# you man what's your angle."

"Make me a market."

"0.11 by 0.16"

"Buy a hundred."

"Done, you mother(#%)0&. You want WEIGHT? I hate carrying this. Next one is 0.20 by 0.25"

"Buy a hundred."

"DONE. You through with me yet?"

"Make me a market for 1,000 contracts."

"YOU MOTHER()#%0# #O%'#(&')$#$ ((#) '%)(#%). 0.30 x 0.35."

"Buying 1,000."

"DONE YOU #%)0#0%)."

And the reason the marketmaker just hated that interaction is because they now have what is politely referred to as "inventory risk." Market makers by definition don't want exposure to the market, they just want to harvest non-directional order flow, where buys and sells roughly cancel each other out, capturing the spread each time and making out like bandits. (In the case where the market maker's second conversation was someone selling the same option rather than buying, they just made $500 for about a minute total of work. A "seat" on the CBOE, which is the license part of the license-to-make-money, costs millions. The lucrative ability to collect a little toll from marker participants is why.)

But once in a while, you get stuck with inventory risk. And, if you're stuck with inventory risk by being short in grossly out-of-the-money call options close to expiry, the vast majority of the time that's great news! They expire worthless.

But they don't have to expire worthless. There's literally thousands of contracts which expire every month worthless, and (statistically speaking) a handful which go from being worth pennies in the morning of expiry day to being worth dollars in the afternoon.

You probably shouldn't feel badly for the options market maker here, except in the general sense that you should feel badly for people who underperform at their jobs. He's suppose to place orders that he'll be happy when the fills come in. (i.e. When his offer to sell a call option is matched with someone who inexplicably wants to buy them at a penny a contract.) He got the fills.

His problem is that a counterparty was smarter than he was and put in buy orders in response to late-breaking information before he could cancel his sell orders. Which is unfortunate, from his perspective, but avoiding this is literally his only job.

This is, incidentally, the whole premise of Flash Boys: people with lots of stock to shop are the guy getting sworn at in the above conversation with a marketmaker. They would prefer that marketmakers always buy 100k shares from them at a go without experiencing any price slippage. Market makers do not like this, but can't do much about it. HFTs are much better at making markets than humans are, and are capable of managing the risks of large block trades better. Some people who preferred getting an exceptionally good deal from human market makers would prefer dealing with them instead of algorithms which can actually, you know, do math many times a second for an entire trading day.


When I worked in options market making, this was the whole reason the firm closed its single stock desk. If you don't have the flow, you are the guy who ends up holding the bag. With single stocks, it's especially hard because costs are high, you have extra operational risk, and you need a sales desk to get you the juicy structured products. My company was an old school ex-floor trading shop. They'd get run over by the banks over and over.

The other side of this can be pretty sweet. You get lots of flow from sales people, who are basically ripping off clients 3-7% on structures. If you have a variety of stocks you can also do some dispersion trading against the index.

One thing to note is you aren't betting on the options expiring worthless. It mostly pure vol spread, just dump everything in a book, hedge the deltas, win if it realises different than implied. Maybe back book some out-of-the-money options so you don't get killed on bleed (Taleb's book Dynamic Hedging explains this).


I like the market making vignette, but in reality the market maker would certainly be hedging his delta as the orders came in, and for a very one-sided options trade like this he would probably be putting on a vega/gamma hedge as well.

For those who don't speak the lingo of options, this means that he'd be hedging his exposure to directional stock price moves (by buying stock as he sold the calls) and also hedging his exposure to the size of stock price moves (volatility) by buying some cheap volatility, say at a different strike or for a different expiry, to cover the expensive volatility that he's just sold.

But like I said, I like the vignette :)


Floor traders are not there to take the other side of a trade. The minute your market maker completed his option trade he hedged it by buying or shorting shares at the equiv delta risk. This is one reason spreads widen on option sales when the market gets busy, and the reason there is put side volatility skew. In both cases it's covering the risk that the price will move before they can hedge their position.


I wrote options software for 4 years (and was in FinTech for 12) and I am just writing this to say that this is right (in case you are wondering).


If the type of trading discussed in the article becomes more common, would market makers stop making markets for these deep out of the money options? Presumably this would be bad for those attempting to use the options as a hedge.


They aren't allowed to stop making markets, at least in the options market. (This is not true of market makers generally. You or I could, if we had a lot of money, start making markets in any stock we desired to, just by getting a brokerage account and sending the right orders to the exchange. A market maker is a participant like any other and may not be a formal role.)

What would probably happen is tweaking their risk exposure: be less willing to play large resting bids/asks for large positions close to the NBBO, and instead either resize them or layer them over several price points.

My feeling with regards to the fairness of this is that one should not offer to sell 4,000 PUTS for e.g. Zynga at $1 in May 2015 unless one is prepared to accept delivery of 400k shares of Zynga in return for $400k. Some options market participant is signaling their willingness to do that, or something close to it. They are theoretically responsible adults who know the risks. If that trade blows up in their face, and they take to the Internet to decry the unfairness of it all, I will not be maximally sympathetic. (Full disclosure: I was probably their counterparty a time or two buying the option on "Zynga blows up in next short-increment-of-time" and did poorly.)


They could make the spread wider after the first 500 contracts go off in a certain interval. Even the in the S&P outcry pit in Chicago sometimes the bid/ask spread goes wide or even no bid when things move too far or too fast for comfort. Next time a jobs number comes out or other financial data point look at the spread right before the number is released. These marker makers are survivors, if they're nervous about inventory risk they shrink size and you get thinner markets (bid/ask sizes) or wider spreads. Of course, if the options market shows something very out of sync with the underlying that is a signal that something is up or there is a market force that hasn't yet caused the underlying to move. Because an American option can be exercised anytime before expiration both options and the underlying stay pretty closely aligned with each other using the theoretical pricing model of each market maker.

I'm sure this trader has programmers working on this problem and putting in some type of limiting such that he doesn't sell off 3000 contracts in one go for a very cheap option close to expiration. 3000 contracts is nothing in SPY options but for a single name stock (not an ETF) it can be considered a sizable trade compared to the open interest.


There is a subset of market makers in NYSE stocks, for example, that have contracts with the exchanges that require them to stay in the market regardless of how bad things are. I know of one such firm that did quite well on the upswing part of the flash crash, as other big firms bailed.


>>*Correction, April 21, 2015: This article originally >>misstated that a purchase of options on March 27 >>immediately followed a tweet by journalist Dana Mattioli. >>It occurred 19 seconds before the tweet and followed a >>newswire post by one second.

So the title of the whole article is totally misleading. It has nothing to do with Tweets & Twitter.

Maybe the same bot (script) has done dozens other trades (false positives) at a loss before.


I wonder how accurate the timing is, although 19 seconds is a very long time to be off by.


'A web-reading bot lost millions on the options market' also happens too.


If you feel entitled to your business, and someone starts taking it away, that will feel like robbing, yes.

But it is pathetic for a serious businessperson to feel entitled to their future business success. That's the kind of pride that comes before a fall.


Honest question.

Let's say that I want to experiment with some language processing and bet some dollars on parsing news like these. I have decent general programming skills, and have experimented with parsing stuff, but never touched trading.

Where do I even start?


There's a Udemy course. Might be a way to start?

https://www.udemy.com/build-your-trading-robot/


I've spoke to a few people who's jobs are to be on top of these sorts of trades and they said the most interesting part of these trades are that the moves precede the jump in the stock. You look at the market data, the options prices pop before the stock price. This is interesting because the options market is almost by definition slower than stock markets (not just because of the presence of HF firms in the underlying markets, but think of Black-Scholes - one of the inputs to the model is the stock price). Many firms aren't yet prepared for this sort of activity, but they'll plug that hole.


There is a whole class of point and click trader out there that brings up the Bloomberg NEWS function (scrolling news), waits for the red flash (breaking important news), and steamrolls over unaware market makers. Most of those market makers are electronic.

It's been happening forever and of course it's now going to get automated. And the electronic market makers will use the same techniques to cancel orders so they don't get run over. The only people worse for wear will be the human market makers and the human point and click traders who can no longer compete.


Lime Brokerage was part of Mark Gorton's Lime Group (also as in 'LimeWire'), though it has been sold. (http://www.marketswiki.com/mwiki/Lime_Brokerage) He also runs Tower Research Capital, which is an HFT firm that recruited pretty heavily at CMU when I was there. Their webpage says: "In the course of developing its current trading strategies, Tower Research Capital LLC has built a powerful set of analytical tools and an automated trade execution infrastructure, which it is leveraging to pursue new trading opportunities. The company is made up of a rare combination of highly proficient individuals with backgrounds in a variety of fields: mathematics, computer science, statistics, physics, economics, engineering, and finance."

That's who seems likely to be doing these trades to me.



Onewaystreet brought up the notion that it's not insider trading if you wait a "reasonable" time after information is made public. Given that the appearance of decent news-reading bots that can act on the <1s timeframe it would seem that reasonable time is essentially the instant that the news hits the wires. Would it be legal to set up a platform where insiders could pre-stage orders with triggers to execute after waiting for the requisite 1 second after news breaks?


This analysis is all based on the asumption that the tweet was the first public info about the possible buy. The bot story is pure speculation.


Not like the tweet actually in reality matters, the value of stock is not related to what happens to a company.

It is related to what people think that other people think is related to the stock value.


It seems to me that the obvious conclusion here is that short-term options are underpriced due to the risk of people trading on news before the market-makers find out about it.


Seems like this is just integrating over random walks and interpreting as skill


How do the bots continuously monitor news feeds without being blocked?


The same way you or I do.


as soon as the other players on the market will be doing it this turn to a zero sum game the money is already been made we can all walk now


I once wrote a special-purpose database kernel - not SQL, the database engine itself - for a Bahamian hedge fund.

It is because of my experience with that hedge fund that I won't take quantitative investment work anymore. I came to regard it as unethical.

I would not be in any way surprised if it were my former clients that pulled this off. There were some smart people there.


What was unethical about it? Quantitative investment work can mean a lot of things.


I was enabling an already wealthy man to become even richer, at the expense of unsophisticated investors.


Isn't it rather patronizing to dismiss "unsophisticated investors" as unworthy of full agency in the stock market? Doesn't "unsophisticated" in this case just mean "they wound up losing money," in a game they voluntarily and without coercion signed up to play?

Suppose instead that the hedge fund had lost money. It happens every day. Would you suddenly start to pity the unsophisticated hedge fund managers being exploited by all those other vicious investors?


I'm not doing anything to prevent unsophisticated investors from making poor choices with their money.

However I do not wish to contribute to making their misfortune even worse than it would otherwise be.


Why would unsophisticated investors lose money? Speaking as an unsophisticated investor, I can confidently say that these rapid trading schemes have not affected my portfolio at all, except perhaps by adding liquidity when I tried to buy or sell equities. Just because this "flash-trading" scheme exists doesn't mean that everyone could or should use it; most unsophisticated investors know enough to stay out of it.


The hedge fund only had one person's money in it. When he made money on a trade, that money had to come from somewhere.


One can make money in the stock market without any trading at all; Merton Miller often emphasized that prices could adjust to new information without any trades taking place, if asset holders and potential buyers agreed on the impact of the new information on the asset value. Trades only take place when asset buyers and sellers have differing valuations for the same asset, whether it be for reasons of uncertainty, asymmetric information, or subjective values. You are also assuming that stock trading is like gambling, where the amount of money at the table is not variable over time (except for players coming and going); this is the zero-sum fallacy.


"assymetric information".

The owner of the hedge fund had a model that was built on decades of CBOT commodities futures prices. His model would buy and sell a basket of about 1000 many times per day. There was some error in his model - at times he would lose money - but over the long run he was able to earn far, far more money than any other fund I've ever heard of.


The stock market is not a zero-sum game because net new money is usually entering the system from outside -- people make money in some other line of work and buy stocks with it.


The obvious contender for doing this would be IBM's Watson.




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