(c) 2020 van tharp institute

How Big Money Trades

Section 3:

Copyright (c) 2020 Van Tharp Institute

Disclaimer

U.S. Government Required Disclaimer – Commodity Futures Trading CommissionFutures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Do not trade with money you cannot afford to lose. This is neither a solicitation nor an offer to Buy/Sell securities or options. No representations are being made that any account will or is likely to achieve profits or losses similar to those discussed in this workshop or in any products or services. The past performance of any trading system or methodology is not necessarily indicative of future results.

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Disclaimer (Continued)

Anyone trading options on securities should view the Options Clearing Corporation's Options Disclosure Document (ODD) at https://www.theocc.com/about/publications/character-risks.jsp? Prior to trading options on any security.

All trades, patterns, charts, systems, trading strategies, etc., discussed in this workshop and the product materials are for illustrative and educational purposes only and not to be construed as specific advisory recommendations. No system or methodology has ever been developed that can guarantee profits or ensure freedom from losses. No representations or implications is being made that using $harpeCoach products, services, or trading systems will generate profits or ensure freedom from losses.

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https://www.theocc.com/about/publications/character-risks.jsp?


Investments or strategies mentioned in this workshop, including any handouts, may not be suitable for you. This material does not take into account your particular investment objectives, financial situation, or needs and is not intended as recommendations appropriate for you. You must make an independent decision regarding investment or strategies mentioned in this workshop, including any of the handouts. Before acting on information in this workshop, you should consider whether it is suitable for your particular circumstances and strongly consider advice from your own financial or investment adviser. Investors should be aware of potential risks involving options trading, including losses beyond 100% of capital invested, and are advised to consult with an investment professional.

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Terms of Use: Your use of these educational materials indicates your acceptance of these disclaimers. In addition, you agree to hold harmless, Charles Whitman, SharpeCoach LLC and Whitman Asset Management LLC, Dominic Boire, DGB Investing Inc, Van Tharp, International Institute of Trading Mastery Inc, Van Tharp Institute, Bruce Walicek and Radian Capital Advisors, personally and collectively for any losses of capital, if any, that may result from the use of the information.

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Today’s Objectives:

Finish General Market Structure Material– Hedging and Type of Trading Strategies

Finish Material on Equity Market Structure– Introduce Equity Market Structure and Thoughts– Hedging and Type of Trading Strategies within Equity Markets– Roles and Strategies of 4 Market Participants within Equity Markets– 7 Edges of Big Money Traders within Equity Markets

Questions and homework from last webinar Guest Speaker: Q&A with Gary Sandlund

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Section 3:

Hedging and Types of Trading

Strategies


Hedging - Objectives

Go over ways to hedging and what is hedging

Go over 3 types of trading strategies– Mean Reversion– Trend Following– Predictive

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Hedging

Successful businesses identify their edges and strengths and focus on enhancing and monetizing their strengths.

The other elements of the business they seek to outsource or minimize.

Hedging plays a key role in being able to maximize their edges and minimize other areas.

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Hedging

A business wants to focus on running its business.

– Consider a company like Tyson Foods.– Their strength is their ability to raise and process chickens.– To allow them to focus on their strengths, they hedge their feed and transportation

costs.– This allows them to do a superior job of managing their business because they know

what their input costs are.– They know what feed costs; they know what it will cost to get feed to them and to

deliver processed chicken to clients.– This allows them to focus on improving the process in which they raise and process

chickens.

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Types of Trading Strategies

There are 3 Type of Trading Strategies:

1. Mean Reversion2. Trend Following3. Predictive

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Mean Reversion: Mean Reverting strategies identify a pricing that is out of alignment with

Fair Value and place the trade expecting the market to revert to Fair Value

As we learned in Week One, the market always reverts to Fair Value. The question is how?

1. Prices revert to the Mean2. The Mean catches up to Prices

Mean Reverting Strategies need prices to revert to the mean (#1) to make money. If the mean catches up, they will likely lose money.

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Mean Reversion:

Markets are a complex web of similar and correlated products and derivatives of those products.

This web acts to dampen the impact of large orders because impact is dispersed over an array of correlated products that are utilized in Mean Reversion Strategies.

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Mean Reversion:

The Quant Market Making Community have strong beliefs supporting Mean Reversion Trading.

– They view markets as efficient– Statistical frameworks as ways to identify mispricing.

Commercial Community also has strong beliefs about Mean Reversion. They believe as prices get further away from the Mean, better opportunities present themselves to profit from mispricing.

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Types of Mean Reverting

Trading Strategies

1.) Arbitrage2.) Relative Value Trading3.) Statistical Models in single product

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Trading Strategies

Arbitrage: Arbitrage is the relationship at the heart of every market. Arbitrage relationships exist inside the market you are trading and vs.

similar markets to the one you are trading.

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Trading Strategies

Arbitrage:

Understanding arbitrage relationships are important because they affect fair value.

Example: When we see someone buying SPY for instance, we think price of SPY should go up. How come it doesn’t? Arbitrage is often the answer. As a large fund is buying SPY, it’s possible that at the same time another large fund is selling ES futures. There is an arbitrage going on between SPY and ES

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Arbitrage (Continued):There are different levels of arbitrage from simple to complex: Same product between different exchanges

– Bitcoin - Bitmex, Binance, CME– EURUSD – FXCM, Forex.com, Currenex– AAPL -- on different exchanges

Same product but different contract specs at same exchange– ES vs. Micro-ES

Regulatory Arbitrage (CFTC vs. SEC)– ES vs. SPY, QQQ vs. NQ, VXX vs. VIX

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Arbitrage (Continued):There are different levels of arbitrage from simple to complex:

Cash vs. Futures (Cash grains vs. Futures, Cash FX vs. Futures)– EURUSD across different platforms vs. CME 6E Futures– Corn in Decatur vs. CBOT Corn (https://dtn.ilfb.org/index.cfm?show=31&mid=5)

– Specific Treasury Note vs. 5-Year Note Future• https://www.bloomberg.com/news/articles/2020-03-17/treasury-futures-domino-that-helped-drive-fed-s-5-trillion-repo?sref=p4NRaxCc

Between product and its derivatives (Crush, Crack)– Soybeans (5,000 bushels) crush to Soybean Meal (100 ton) and Soybean Oil (60,000

pounds)

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https://dtn.ilfb.org/index.cfm?show=31&mid=5

https://www.bloomberg.com/news/articles/2020-03-17/treasury-futures-domino-that-helped-drive-fed-s-5-trillion-repo?sref=p4NRaxCc



Same product and its derivatives (Futures/Stock vs. Options –Conversion/Reversals)– +100 AAPL vs. -1 V 460 Call + 1 V 460 Put = Conversion

Same product vs. its components (ES vs. Stocks in ES)– Program trading (basket arbitrage) – Sell ES/+ Stocks making up ES (correlation)– https://www.cnbc.com/2020/07/22/these-six-tech-stocks-make-up-half-the-nasdaq-100s-value.html

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https://www.cnbc.com/2020/07/22/these-six-tech-stocks-make-up-half-the-nasdaq-100s-value.html


Arbitrage (Continued):There are different levels of arbitrage from simple to complex: Same product vs. its components (NQ vs. Stocks in NQ)

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Convertible Arbitrage (Convertible Bonds vs. Stocks)– + Convertible Bond (with right to buy stock)/- Stock (2008 Example)

Merger Arbitrage (Merger between 2 companies)– Merger Announcement sets terms. Stock will trade around those terms until deal closes.

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Relative Value/Spread Relationships: Intermarket Spreads (Corn spreads, Eurodollar spreads)

Intramarket Spreads (ES vs. NQ, ZN vs. ZF)

Butterfly Spreads (ZT/ZF/ZN or +1CLF1/-2CLM1/+1CLZ1)

Options on Spreads (CSO – Calendar Spread Options)

Pairs relationships (GOOGL vs. AAPL)

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Models: Model based trading strategies are more complex than standard RV strategies

Statistical Arbitrage

Volatility Trading (Volatility skew)

Term Structure Curve Trading (interest rates, commodities)

Mean Reversion Models

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Trend Following Strategies:

– Quant community tends to be more dismissive of trend following strategies unless they are flow based. I think this is a mistake.

– Banks/Proprietary trading firms tend to be trade trends on shorter timeframes because of efficiency and return on capital in Banks/Proprietary trading firms is much higher than other firms so lower return/lower Sharpe systems tend to be ignored.

– Hedge Funds and CTA's are the biggest user of trend following strategies.

– Trends are identified both on discretionary and systematic basis.

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Trend Following Strategies:

– Trends are also identified using both Macro and Micro based tools

– There are trend followers who use fundamental and purely technical techniques

– Trends are identified both on discretionary and systematic basis

– Long term trend following shows a consistent edge because of psychological stress it takes to follow the plan

– Most Retail traders engage in trend-following strategies

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Predictive Strategies:

– Predictive Strategies don't fall into either mean reversion or trend following.– They also are not typically attached to a market environment.

– A predictive strategy might generate a result like "75% of the time, ES is 5 or more points higher 60 minutes after the signal."– It is unknown what the strategy or environment is, just a statistical model that predicts where prices will

be.– Big Data work tends to be used to create Predictive Strategies.

– Jaffray Woodriff/QIM (Hedge Fund Market Wizards) is a great example of a predictive trader.

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Styles of Trading Strategies

Black vs. Grey vs. White Box:

Black Box– Completely automated– Strategy run by preset rules or parameter adjustments– Usually simple strategies (Arbitrages, simple trading systems)

Grey Box– Semi-automated– Core elements are automated– Airline Pilot Example– Strategies are complex and involve human element to manage parameters and risk– Option Market Makers, advanced quantitative model trading

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Black vs. Grey vs. White Box (continued):

White Box– Completely discretionary– Rules are situational and grey– Trader is making all decisions of entry, exit and position management

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Martingale vs. Anti-Martingale Systems

Martingale:– Martingale – double down on losers– Many Professionals practice versions of Martingale strategies (Commercials)

• Average Cost Down on weakness• Average Cost Up on Strength

Anti-Martingale:– Anti-Martingale – double down on winners– Many Retail traders practice version of Anti-martingale strategies with markets money

or campaign trading strategies.

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Section 3:

Introduce Equity Market

Structure and Thoughts


Introduce Equity Market Structure and

Thoughts - Objective

Go over the application of Market Structure specific to the equity markets

Go over how the equity markets work

Provide some thoughts on how the equity market works

Go over some examples of how the exchanges work

Discuss commission free trading

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Introduce Equity Market Structure and Thoughts

Market Structure is a composition of exchanges and Dark Pools (internal flow).

US Equity Market structure has higher levels of automation because of the simplicity of the structure of a stock.

Simpler the product, the higher level of automation in market structure.

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(Continued)

As we talk about Market Participants, the Banks play a huge role in the game.

The bank is often a hybrid of the commercial and Market Maker.

Banks are like casinos.

They want to control the flow by having people trade under their umbrella.

This flow is worth millions for them both in terms of collecting bid/ask spreads but also for information to make other trading decisions.

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(Continued)

The US Equity Market Structure is a blend of exchanges and Dark Pools.

The SEC has worked to set rules designed to create fairness for the average investor and promote competition by banks and exchanges.

This has worked to some degree, but it has also failed by introducing new ways to game the system.

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(Continued)

The SEC created Regulation NMS (National Market System) and as part of the Regulation, created NBBO (National Best Bid/Offer).

NBBO entitles a buyer to receive the best price offered in the US through the National Market System.

Because of competition, the exchange/pool where the order sits could be at a variety of exchanges or Dark Pools, not just at the listed exchange.

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(Continued)

An Example of how the exchanges work in the US Equity Market: Docusign (DOCU) could be 208.60 bid and 208.62 offer with 100 shares

offered at 208.62. – The 208.62 could be offered at CBOE/BATS. – The next offer is 400 shares at 208.63 at NASDAQ Boston – The next offer is 400 shares at 208.64 at CBOE Direct Edge– The next offer is 1000 shares at 208.66 at NASDAQ.

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(Continued)

An Example of how the exchanges work in the US Equity Market: Docusign (DOCU) example continued:

– Let’s say you want to buy 1000 shares. – NBBO demands that you get the best price so you will buy 100 shares at 208.62. – HFT sees your order to +1000 shares and subsequently will race you to +400 at

208.63. +400 @ 208.64 and then sell you 900 @ 208.65. – You will end up with a fill of:

• +100 @ 208.62• +900 @ 208.65 for average cost of 208.647

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(Continued)

An Example of how the exchanges work in the US Equity Market: Docusign (DOCU) example continued:

– HFT +800 Shares at average cost of 208.635 and -900 at 208.65. – They make .015*800 ($12) and are short 100 shares at 208.65. – They have an offer at 208.66 to lean on and will work to buy back the last 100 shares

at 208.64 or lower.

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(Continued)

The effect of this transaction is that liquidity is dramatically reduced which ultimately hurts the customer.

When we look at the order books in many stocks, the liquidity is much lower than it should be for the amount of volume it trades.

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(Continued)

An Example of liquidity in the US Equity markets:

A stock like GSX Tech (GSX) has Daily Avg Volume of 5,800,000 shares a day and ATR of $12.00 should have a bid/offer that is 2,000-5,000 up but usually is only 100 shares on Bid/Offer.

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(Continued)


This lack of liquidity makes intraday trading of Equities more difficult.

It also punishes anyone who posts larger orders because the large order becomes a point of focus for Algos.

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(Continued)


Basically, large orders get leaned on (Remember flow?) and only get filled when you don’t want them filled.

As a result traders end up using Volume based Algos to enter and exit.

This makes entering and exiting at your levels difficult and can result in massive slippage.

At the minimum, you go into situations where you need to trade with uncertainty of where you order will be executed.

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(Continued)

In general, liquidity in futures is much better than most listed stocks.

Some exchanges (IEX, CBOE) have created infrastructure to take away slow arbitrage from HFT.

– IEX – 350 Microsecond delay to time up order to arrive at same time– Introduction of Batch Auctions on CBOE-BYX – aggregate buys+sells and match every

.1 seconds

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(Continued)

Commission Free Trading – How do Brokerages make money if they let you trade for free?

The answer is that Banks/Prop Trading Firms pay the Brokerage for the right to make markets for their clients.

As you can see below, this adds up to hundreds of millions of dollars for the Brokerage.

Interactive Brokers (where I hold accounts) is the only brokerage I know of that doesn’t take payment for order flow.

https://www.warriortrading.com/payment-for-order-flow/#:~:text=Payment%20for%20order%20flow%20is,in%20your%20TD%20Ameritrade%20account.

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https://www.warriortrading.com/payment-for-order-flow/#:~:text=Payment%20for%20order%20flow%20is,in%20your%20TD%20Ameritrade%20account


(Continued)

Commission Free Trading – How do Brokerages make money if they let you trade for free? Excerpt from Flash Boys: A Wall Street Revolt by Michael Lewis, pages 179-180

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(Continued)


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(Continued)


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(Continued)


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(Continued)


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(Continued)

Commission Free Trading – How do Brokerages make money if they let you trade for free? (Continued)

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(Continued)


Robinhood:

Robinhood has been all the rage lately. However, the payment for order flow is > 10x higher for Robinhood than

typical brokerages. This tells you that the Marketmakers view this flow as gold.

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(Continued)


Robinhood (Continued):

– Why would that be the case? Robinhood pushes the ability to trade fractional shares of stock.

– However, you are only allowed to trade fractional shares of stock via market orders.• https://www.investopedia.com/terms/f/fractionalshare.asp• "Fractional shares don't trade on the open market; the only way to sell fractional shares is through a

major brokerage." - This is key• As a side note, odd lots (orders < 100 shares) are not bound by NBBO

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https://www.investopedia.com/terms/f/fractionalshare.asp


(Continued)


Robinhood (Continued):

– What happens is that Robinhood bundles you order with other orders to effectively create whole shares.

– This would be too hard to do if they orders were limit orders.

– Instead, market orders can be easily bundled. Market orders have the highest edge per trade of any order type.

– Market Makers love market orders!!! Robinhood is full of thousands of market orders every day.

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(Continued)


Robinhood Example: Citadel Securities used to make markets in equity options for E-Trade.

Their algorithm would trade all orders < =20 contracts for themselves.

Small orders have little risk and often large margins.

If an order was > 20 contracts, they would route the order out of E-Trade out to one of the exchanges.

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(Continued)


Robinhood Example:

Citadel had optionality to take the orders they wanted and give away the rest. Sounds pretty good right?!?

This strategy is how trading Dark Pools typically work. The small orders stay internal and the threatening orders are routed out

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(Continued)

Exchanges3 Main Exchanges (of 13 Total) – 12 of 13 owned by ICE, NASDAQ or CBOE NYSE/Arca NASDAQ CBOE/BATS

Largest Dark Pools: UBS ATS Credit Suisse JP Morgan Luminex (Blackrock, Fidelity)

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(Continued)

Exchanges (Continued)

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(Continued)

Exchanges (Continued)Largest Banks and Market Makers: 1. Morgan Stanley 2. Goldman Sachs 3. JP Morgan

Largest Market Makers: 1. Citadel Securities 2. Virtu 3. Susquehanna

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Citadel Securitieshttps://en.wikipedia.org/wiki/Kenneth_C._Griffinhttps://www.citadelsecurities.com/


https://en.wikipedia.org/wiki/Kenneth_C._Griffin

https://www.citadelsecurities.com/


(Continued)

Exchanges (Continued)

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Section 3:

Hedging and Type of Trading

Strategies within Equity

Markets


Hedging and Types of Trading

Strategies - Objectives

Go over heading and types of trading strategies specific to the equity markets– Stock Buy Backs– Insider activity– Tracking Sentiment

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Hedging and Types of Trading Strategies

Stock Buy Backs

As we transition into the commercial behavior in the debt market and equity market, we start to see the second type of commercial behavior which is manipulation.

We won’t see this mentioned often because manipulation (especially using the word) is taboo.

In equities, we see a combination of these behaviors, but we see a great deal of manipulative behavior.

I ‘ve attached a link from an article from Motley Fool on how stock buybacks work.

https://www.fool.com/investing/how-stock-buybacks-work.aspx

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https://www.fool.com/investing/how-stock-buybacks-work.aspx


Stock Buy Backs (Continued)

Typically, a stock buyback is a value-based trading approach by the company.

Its intelligent and reasonable. As you can see from the example in the link, if we as a management team

know that based on our models the fair value of our company is $100/per share, then we could look at the imputed return on capital by buying the stock cheaper than $100 and compare that return with other potential investments of capital and choose the solutions that give the highest Return on Investment (ROI).

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Let’s use an example of a stock buyback:– Fair Value of the stock via our model = $100– Stock price currently trading $75– We could work to buy back shares of our stock at $75 and if stock rallied back to fair

value, we would make a 33% return ($25 profit/$75 stock price)

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There is a second aspect of this behavior which is the actions of the insiders.

Insiders are executives, board members, and or advisors to the firm. In addition to the company purchasing shares via buyback, insiders can

purchase shares themselves (if meeting disclosure rules). Insider buying is usually considered to be a bullish sign for the stock price.

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Conversely, if at stock price becomes too expensive, we will see the opposite behavior.

We may see the company announce the sale of additional shares (to raise capital) to capture discrepancies in fair value vs. their model.

Again, these sales have to be done through proper disclosures (market may react negatively to these announcement).

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Insider sales are much more common. Insiders have their own disclosure rules, but the rules are much more

lenient than for the company. Insider selling is another value-based approach that we can track to see

behavior

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Buying back stock also shrinks the float size of shares. The smaller the number of shares, the more easily buying effects the stock

price. Some of the shrewdest IPO’s I have ever seen only floated small amounts

of stock and then used buying to help push the stock higher.

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In addition, companies engage in options trading on their stock, usually via put selling.– Must meet regulatory disclosure rules– Selling puts on their stock is a way they can accumulate stock at lower prices and be

paid to do so.

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Stock Buy Backs – As a Manipulation Tool

The behavior mentioned above is a rational way to profit from the value of the stock by the company/insiders

The stock buyback has emerged though as a highly manipulative tool. For any economic problem, it's important to understand incentives and

punishments. People will gravitate towards behaviors that incentive them and avoid

behaviors that punish them.

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Stock Buy Backs – As a Manipulation Tool (Continued)

In the case of equities, management teams/employees are usually given performance incentives that are paid via stock or stock options.

Often, stock compensation is much greater than salary/cash bonus payments.

Structuring incentive packages this way makes sense because it:– Aligns the interest of management/employees with shareholders– Granting stock makes the employees a partner of the firm– Granting stock allows the company to pay employees without using up cash to run the

business– Stock appreciation is tax free until sold. Granting stock and the stock increasing in value

allows the employee to make additional compensation via unrealized gains

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However, problems arise when management uses stock buybacks as a tool to increase value of the stock, so they hit their performance targets and increase the value of their holdings by leveraging company assets/balance sheet to fund the buyback.

Instead of our first example, where the company announces buybacks because they know the stock in inherently cheap, they announce buyback to pay high (over fair value) to push the value of the stock higher for their own gain.

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In the last decade, this practice has exploded due to low interest rates.

Management teams, instead of using excess cash to purchase stock via buyback, are borrowing money in the corporate debt market or from their bank to purchase back their own stock.

If the stock returns 10% or more per year and they can borrow money at 5% (or cheaper!), they are making a 5% return on the buyback.

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Remember though this is just the beginning because the buyback is increasing the value of their performance packages and holdings.

The result may mean that stock options now become in the money and exercisable.

Their own holdings are going up in value as well at the expense of the company.

The company is underwriting the risk of the transaction and employees/insiders reap the benefits.

There are several factors such as this that contribute to the upward profile of equity prices.

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It should also be said the buybacks only work to elevate the prices of stocks that are already doing well.

In the case of an announced buyback for a company that is struggling, it often only gives longs who are struggling with the stock a chance to exit by selling to the company.

This ends up usually being wasted money by the company initiating the buyback

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Stock Buy Backs – Risks

It’s important to understand though that this practice could end badly. If the economy turns south and effects the company’s revenue, quickly

profits could turn to losses. Bank loans could be called. If bank loans are called, the company will have

to have the money on hand to repay the loan or they will have to liquidate stock.

A self-feeding negative feedback loop could emerge where the company is losing money, eating up cash reserves while at the same time having both debt payments to continue to be made or loans called.

If the company now must sell stock to raise capital amid the stock going down due to falling profits/losses, the consequences could be disastrous.

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Stock Buy Backs – Risks (continued)

Another aspect of this situation is offshore profits.

Companies have been borrowing money against offshore profits rather than repatriate profits.

If they get in a negative situation, they could have to repatriate profits to meet their obligations.

These profits become taxable at a high rate which means the actual capital available might be far less than expected.

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Tracking Insider Activity Another aspect of this situation is offshore profits.

https://www.gurufocus.com/insider/summary https://www.informa.com/

Tracking Sentiment https://sentimentrader.com/pricing/

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https://www.gurufocus.com/insider/summary

https://www.informa.com/

https://sentimentrader.com/pricing/


Section 3:

Roles and Strategies of 4

Market Participants within

Equity Markets


Roles and Strategies of 4 Market

Participants - Objectives

Go over the roles and strategies of the 4 market participants for equity markets– Go over who the commercials are– Go over who the large speculators are– Go over who the retail investors are– Go over who the banks and market makers are

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Roles and Strategies of 4 Market Participants

4 Market Participants:

1. Commercials– Natural Longs – Companies –

• Stock Expensive – capitalize by issuing stock via secondary offering and through stock grants and options to employees

• Stock Cheap – Announce Buyback and insider buying– Natural Shorts – Large Mutual Funds, Index Funds and Pension Funds –

• Because of their size, they tend to be always long.• They also might be buyers on the way down but could also be buyers on the way up as they have to

adhere to charters and allocation rules. In this case, they act as momentum buyers where they buy all the way up but stop when the stock stops rising and sell when the stock starts to fall.

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4 Market Participants (Continued):2. Large Speculators

– Activists/Value Investors – Trade like Commercials and act like commercials. Buy low/Sell high. High understanding of company balance sheet and company value

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4 Market Participants (Continued):2. Large Speculators – Activists/Value Investors – cont'd

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4 Market Participants (Continued):

2. Large Speculators

– Momentum Funds – Buy Leaders/Sell Laggards Short. Tend to be absolute return-based firms.

– Long/Short Equity Funds – claim to be market neutral but usually have a directional bias around a long/short book. They are working to outperform the market in either direction.

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3. Retail Investors

– Self-directed 401k and IRA’s

– Small retail investors – Robinhood, TD Ameritrade, E-Trade

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4. Banks/Market Makers

– Banks• Investment banking, Order Flow (Dark Pool), Wealth Management, Information• Proprietary trading desks to trade equities via flow, arbitrage, quantative models, options market making

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4. Banks/Market Makers

– Proprietary Trading Firms• Superior Technology• Different forms of arbitrage

– slow arbitrage– regulatory arbitrage– program trading

• Flow Trading (front running)• Algorithmic Trading/Quant Models (Lead, Laggard)• Option Market Making with automated models

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Section 3:

7 Edges of Big Money Traders

within Equity Markets


7 Edges of Big Money Traders – Within

Equity Markets - Objectives

Go over how the seven edges are using by big money trader in the equity markets.

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7 Edges of Big Money Traders – Within Equity Markets

7 Edges of Big Money Traders

1. Expertise in a Market or Strategy2. Trade with Edge to Fair Value3. Trade with Positive Reversion4. Use Flows to Make Trading Decisions5. Identify Asymmetric Trade Setups6. Manage Risk through Spreads and Relative Value (Still being worked on)7. Use Instrument Selection to choose the Optimum Strategy to maximize

their Trade Idea

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Edge 1) Expertise in a Market or Strategy

Specialists in Company or Sector

Specialists in a Strategy1. Momentum2. Long/Short3. Value

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Edge 2) Trade with Edge to Fair Value VWAP across different Timeframes is gold standard for execution analysis Algos more prevalent in Equities than any other asset class

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Edge 2) Trade with Edge to Fair Value VWAP across different Timeframes is gold standard for execution analysis

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Edge 3) Trade with Positive Reversion

Algos use Positive Reversion on Exits and Entries– Algos are consistently used to avoid giving up edge to VWAP whenever possible

Lack of liquidity makes negative reversion exits problematic

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Edge 4) Use Flows to Make Trading Decisions

Volume Footprints are the most obvious in equities

Largest variance in volume in Stocks

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Edge 4) Use Flows to Make Trading Decisions

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Edge 5) Identify Asymmetric Trade Setups

Momentum Stocks Convertible Arbitrage Volatility Expansion on breaks

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Edge 6) Manage Risk through Spreads and Relative Value

Trading Spreads and Pairs– Express market neutral bets via Spreads

• +AAPL/-SPY (Reedstrader Metric)• +AAPL/-XLK• +AAPL/-GOOG

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Edge 6) Manage Risk through Spreads and Relative Value

Michael Platt – Blue Crest Capital Management

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Hedge Fund Market Wizards – Chapter 8



Edge 6) Manage Risk through Spreads and Relative Value +AAPL vs. +AAPL/-4.5*SPY

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Edge 6) Manage Risk through Spreads and Relative Value +AAPL vs. +AAPL/-7.5*XLK

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Edge 6) Manage Risk through Spreads and Relative Value +AAPL vs. +2.5*AAPL/-GOOG

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Edge 7) Use Instrument Selection to choose the Optimum Strategy to maximize their Trade Idea

Trading Options instead of Stock– Margin Efficiency– Protection for Gaps– Customization of strategies to objectives (e-signal)

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Edge 7) Use Instrument Selection to choose the Optimum Strategy to maximize their Trade Idea On 2/3/20, +3000 AAPL @ 308.66 vs. +60 U 310 Calls @ 26

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Date Stock Price Long Stock Only P&L

+U 310 Call Option Price

Option Position P&L ATR

2/3/2020 308.66 26 3600 7.222/28/2020 273.36 -105900 13.25 -76500 10.943/23/2020 224.37 -252870 3.85 -132900 19.973/31/2020 254.29 -163110 6.25 -118500 18.774/30/2020 293.8 -44580 15.9 -60600 8.395/29/2020 317.94 27840 26.24 1440 7.456/30/2020 364.8 168420 61.14 210840 10.317/31/2020 425.04 349140 114.83 532980 12.368/18/2020 462.25 460770 152.7 760200 14.48Copyright (c

) 2020 Van Tharp Institute


Edge 7) Use Instrument Selection to choose the Optimum Strategy to maximize their Trade Idea On 2/3/20, +3000 AAPL @ 308.66 vs. +60 U 310 Calls @ 26

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Margin Efficiency Margin Return % Return on Capital

No Margin 925980 460770 49.76%

Reg T Margin (50% Margin) 462990 460770 99.52%

Option Position 156000 760200 487.31%



Section 3:

Questions &

Homework from the last call


Homework from Day 02:

Break out rooms to discuss the homework from day 2

Homework from day 2:

– List 3 concepts that you learned from today's webinar:

– What's one idea from the 7 Edges of Big Money Traders that you could incorporate into your trading? How would you expect it to improve your performance?

– What beliefs do you hold that should be reevaluated as a result of what you learned today?

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Q&A with Gary Sundlund


Guest – Gary Sandlund

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• Guest Speaker: Gary Sandlund – President of Futures International• Largest agricultural option broker in the United States

• One of largest brokerages in agricultural and softs space

• Extensive experience dealing with Commercials, Hedge Funds and Proprietary Trading Firms

• Gary Sandlund started his career at the CBOT as many did, as a runner on the grain floor in 1987 moving up the through various companies learning all aspects of the industry through various jobs until 1992 when he became a COM member of the CBOT.

• Gary dealt with the largest agricultural importers/exporters across the globe executing complex option orders on their behalf.

• Gary was the 1st broker to adapt to the newest technology in 1994 using cellular (wireless headset) in the trading pits creating the highest level of efficiency to enhance the clients trading performance. Copyright (c

) 2020 Van Tharp Institute

Guest – Gary Sundlund

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• Guest Speaker: Gary Sandlund – President of Futures International• 1997 Gary became a full member (delegate) expanding his expertise and efficiency

into both the futures and option markets.

• As the industry changed in the late 90s from commercial hedging to hedge fund and commodity investments Gary's clientele changed as well expanding and executing for the worlds largest banks, hedge funds and pension funds.

• 2004 Gary along with 2 other partners formed Futures International (IB) providing multiple outlets for clearing to customize customers needs,

• 2009 Futures International sold majority ownership to OTCGH.

• Gary has always adapted and accepted the challenge of change rather than fight against it, from pit trading to electronic trading to now managing one of the largest IB's that has created deep liquidity that enhances all of their clients profitability.


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Homework – Day 3

• List 3 concepts that you learned from today's webinar:

• What's one idea from the 7 Edges of Big Money Traders that you could incorporate into your trading? How would you expect it to improve your performance?

• What beliefs do you hold that should be reevaluated as a result of what you learned today?

• What have you learned from the guest speakers?


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Questions


(c) 2020 van tharp institute

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