EUAN SINCLAIR: I'm Euan Sinclair. This is Real Visionaries.
How are you doing Ralph? Hey, hey. Good boy.
EUAN SINCLAIR: You got to take this stuff up. My name is Euan Sinclair. I'm an options trader for 25 years as various types of trading, market making, prop trading, ran a hedge fund for a little bit, and a few options books you might have heard of. Right now, Ralph and I are doing a road trip around America going back home to Chicago from Palm Springs.
On the way, we thought it would be a nice opportunity to talk to some interesting people. These are very much the sort of interviews where I'm like, you know what, I hope other people get a lot out of this, but I know I will. I got to talk to some people that I've known for a while in various forms. We started in San Diego with Augustin Lebron, who wrote a very interesting book called The Laws of Trading. It's just not about trading so much as like the meta aspects of trading.
AUGUSTIN LEBRON: I think a lot of people in trading situations that are in professional trading situations, they think they have edge. They think they're good, but really, the value is in the seat. And so there are a lot of maybe misaligned incentives in professional trading firms. A good trader should probably just be optimizing for what their bonus pool and what their bonus outcome is as opposed to broadly speaking, making the most money possible. They're not the same incentives.
Whereas retail traders, because they're on their own, they're doing everything. Their incentives are perfectly aligned. And so, that is an advantage. It's not an advantage that necessarily overcomes the disadvantages, but it is an advantage.
EUAN SINCLAIR: Here, I'm in beautiful Las Cruces in an even more beautiful state of New Mexico, talking to Aaron Brown, who I've known for 20 years. He's very interesting that he was the answer to the question, who knows most about finance of every type. And the answer to that is always Aaron Brow. He started off as a professional poker player. He was a trader. One of the inventors of value at risk. The last job was the Risk Manager at AQR.
AARON BROWN: To me, risk should be used for a two-sided opportunity. Something that can be good or can be bad. Dangerous for things that can only be bad, opportunities for things that can only be good. Basically, danger should be minimized, and opportunities should be maximized. That's easy, at least conceptually doing it can be difficult. Risk, you want to take the optimum level. Risks should be optimized.
Back in the late 1980s when we were struggling with these ideas, and I'm talking about me and some other quantitative traders in New York. We wanted to call our field something. We deliberately chose the word risk management. The only other people who were using it, were using it in our sense of the word. They were consulting insurance people who told companies, here are the risks you should self-insure, because they're statistical predictable. You can't get ruined by them.
Here are the things you should buy third party insurance for because they're so big, or they're so unpredictable that you want somebody else to take them and that was called Risk Management. The term very quickly got interpreted at large as risk minimization or danger minimization. So, people are shocked to find out the risk managers typically spend their time trying to get people to take more risk.
EUAN SINCLAIR: We're driving through next into Kansas, where I'm hoping to meet up with Bill James, who is mainly famous for inventing sabermetrics in baseball, and that entire analytics movement in sports teams to him. I think it's very important to talk to him. Not about that, but about his thought process.
He thinks about the world exactly the way I think a good trader should. He sits down, formulates a very well posed question, and then applies whatever statistical techniques he needs to do to answer that question, and he's not bound by what you should do mathematically. He's not a statistician. If anything, I think of him as a detective. He thinks of himself as a writer, but we're going to disagree on that one.
BILL JAMES: The replacement level is the level of a player who's just pretty much freely available. And that was an idea that I came up with in the 1980s. I borrowed from economics. It's just marginal wins. The margin said they set at the level of replaceable player. In theory, wins above replacement is a measure of how much better you are than a replaceable player.
In theory, we all like that better and it is very commonly used. Win shares is more absolute. Share of a win is a third of a win. If a team wins 100 games, they have 300 win shares, absolutely in all cases, not wins above replacement, but wins period.
EUAN SINCLAIR: I think traders can learn a lot from him, because essentially, he's teasing out information from a field that's got a lot more noise in it than data. And that's really what finance is all about. Then finally, I'm going to be talking to my friend, Charles Tall, who was the founder of Archelon Trading, one of the biggest option trading firms in the world.
As you get older, it's harder to find genuinely new pieces of knowledge. I've always found it interesting to talk to Charlie. He's sort of the generation before me in options trading, but we have a fairly similar take on the world.
CHARLIE TALL: Market makers, it's like a very interesting boxer. It's a boxer against the market. This boxer is going to be hit from the left, which is a buy from the market, so he sells and hit from the right. When he gets hit twice in a buy and a sell, he doesn't get hurt. He actually doesn't get many much bigger, but he doesn't carry pain.
If he gets hit a lot, a lot a left and one right, a lot a left and one right again and again and again, pretty soon he's on the ropes and he's damaged. Because to get hit that many times on one side, you've already lost money, because you don't stand there and sell forever at the same price. You sell, fade, sell, fade, sell, fade.
That means you've lost as many times as you faded so far on your first bet, one minus as many times as you faded on your second bet, and the markets betting against you as a market maker when it comes to you that way. So, you've already lost a reasonable amount on this. Then you're up against the rope when you run out of your ability to take more punches.
EUAN SINCLAIR: I hope you enjoy this. Ralph and I have enjoyed it. It's a nice way to break up a trip across America. You don't realize how big America is until you start driving across it.