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The Options Pit
The Smart Profits Report: Issue #153
Thursday, October 21, 2004
The Options Pit: Controlled Chaos In the Pits at the CBOE
By Karim Rahemtulla
Chairman, Mt. Vernon Research
I just returned from hosting Agora Financial Options Seminar earlier this month in Chicago. For options traders, Chicago is where the action is, literally.
I talk about market makers and the options pit or “the floor,” but once in every trader’s life it’s worth seeing your opponents in action… to see how they exist in an environment that would overwhelm the rest of us.
Trading with the Pros - On Their Home Turf
On the afternoon of the first day of our annual Chicago options conference, our entire group - Smart Profits readers included - was treated to a tour of the Chicago Board of Options Exchange, CBOE, and a “live” interactive trading session.
This was the first such session since 9/11 - and it was a hoot.
After passing through airport-like security we were hustled up to the fourth floor for a 30-minute sit-down seminar by one of the top traders at the exchange. We all received authentic badges with our names embossed on them and the exchange logo as a token of our participation. The we all donned our trading jackets… some proved to be a tight fit… Traders are a very trim lot.
Learning to Shout In the Option Pits
We headed down to the pits after closing. What a sight. Thousands of monitors lined every available wall and thousands more hung suspended from 40-foot-high ceilings. Huge boards flashed the latest bid/offers on numerous options and the news tickers ran non-stop with all of the breaking news.
The option pits were sectioned off in areas that were set up to trade a number of options. (For example, in one of the bigger pits floor traders may be following 10 or 15 different companies at the same time.)
We then began the mock trading session. In groups of seven or eight, we were matched up with a professional trader who explained how to bid for options contracts and how to sell them. Hand gestures that would probably get you beaten up in some countries around the world were explained.
Then the bell rang…
“20 contracts to buy at the bid,” screamed one trader.
“50 for a nickel above,” screamed another. I kid you not: These guys were going at it at the top of their lungs for over half an hour, just for our session. Yells and screams came from every direction, papers were flying through the air as orders were marked and filled.
The Underbelly Of The Options World: The Options Pit
The traders were hyper alert - keeping one eye on the share price, the other on the option price. It was utter chaos… and yet this is how an open outcry market has functioned for decades. It’s picturesque, but…
While the open system is something to behold, fortunately many options are now traded electronically. I walked away not feeling very confident that the open outcry system works in our favor as individual investors.
After all, these traders know each other very well and there has to be huge potential for abuse. Everyone there reassured me that compliance was tough, safeguards were in place to prevent abuse and the traders operate under a very strict policy that ALWAYS puts the customer’s interests first. Much as I would like to believe that… all I can say is… RIGHT!
I put more faith in what I see every day… erratic pricing in options, spreads that mysteriously widen, prices on calls that go down as the stock goes up… Sure these anomalies correct quickly enough, but this look at the underbelly of the options world, the options pit, reminded me of why I write this Report: We can never protect ourselves TOO much from the chaos inherent in the options market.
Good Trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- Check out our Smart Profits Glossary for definitions of words like “market maker” or “CBOE” found in today’s article.
- For more on the Market Maker, check out Smart Profits #212, Beating the Market Makers: Never Pay Full Price
Related Articles:
- Market Maker Downtime: How to Make $1,000 On a Slow Day In the Options Pit
- Market Makers - Hand Signals, Stress and Million-Dollar Trades
- Market Maker Survival: The Options Pit “Caste System” Revealed
