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A web-reading bot made millions on the options market

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Re: A web-reading bot made millions on the options market

#111
post #14

Earlier quoted context omitted.

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 ri…

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.

Re: A web-reading bot made millions on the options market

#112
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.

Re: A web-reading bot made millions on the options market

#113
post #59

'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,’ ”…

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?

Re: A web-reading bot made millions on the options market

#114

Earlier quoted context omitted.

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.

Re: A web-reading bot made millions on the options market

#115
post #99

Earlier quoted context omitted.

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.

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

Re: A web-reading bot made millions on the options market

#116
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?

Re: A web-reading bot made millions on the options market

#117

Earlier quoted context omitted.

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.

Re: A web-reading bot made millions on the options market

#118

Earlier quoted context omitted.

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?

Re: A web-reading bot made millions on the options market

#119
post #63

Earlier quoted context omitted.

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.

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.
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