Let’s classify the traders on the floor:
“Locals” are independent traders. They trade their own money and secure the right to trade on the floor by owning or leasing one of the limited seats which represented an ownership stake by the exchange’s “members” (this was before demutualization). Since they are not as well funded, locals trade smaller and focus on extremely high Sharpe (although they wouldn’t use this lingo), low capacity opportunities. They tend to be seasoned and run tight risk. Many were independent-minded misfits, allergic to jobs and W2s.
- Prop firms
Some of the big prop shops included Group One, Timber Hill (IBKR), Jane Street, CTC, DRW, Cooper Neff, O’Connor, Cutler, Wolverine, and my alma mater SIG.
Traders representing these firms usually have a salary and bonus. The bonus could be discretionary, formulaic (ie 20% of your p/l), or a hybrid. Firm traders tend to be more pedigreed, younger and less autonomous. They are well-resourced, well-capitalized, and can trade big often answering to the “mother ship”.
[A little digression. There’s a 3rd class of trader which is a “backed” trader which blurs local and firm. These firms were usually tied to clearing firms and offered economies of scale in risk management, software, data, clearing rates. I left SIG in 2008 to get backed. From 2009-2012, I put up escrow with a firm whose business was to bankroll traders. In my case I got 70% of my p/l, and I could sleep knowing I couldn’t lose more than escrow. Giving up 30% was worth it to me. My backers were well-capitalized and allowed us to trade as big as firm traders (but our escrows ranged from 6 to 7 figures). We answered to risk managers as well. But for the most part we were left to build teams and businesses as we saw fit.]
- The floor is competitive.
If a broker lifts the pit’s offer for 500 contracts, market makers fight for “recognition”. If 10 people scream “sold!” the broker gets final say on who they “heard”. Everyone wants an allocation. The power of the broker’s discretion means politics, justice, and game dynamics all come in to play as traders scrape for market share.
- The floor is also cooperative.
It’s an emergent trust system since you are moving large sums of money by the sound of your voice. Even a den of thieves has a code of ethics. Word is bond. Welch on a broker and you might as well be invisible to them from that point forward. This trust system is further reinforced by incentives. Yes, you are competing with each other, but the broker flow is the ultimate source of compensation. It’s the life blood of the pits. Everyone on your exchange wants the flow to keep coming. Traders, brokers, and the exchange itself. There’s an informal favor system or quid pro quo that ultimately serves the broker’s clients not having errors. Nobody wants clients taking their ball and going home.
- The floor is made of humans
You cannot help but make friends with many of the people you stand shoulder to shoulder with all day. After all, you share common interests. You want to know each other’s comp deals…I joined my backer because of a friend I made on the floor (thanks Mike!). You exchange trade ideas with the people you are close with. It was even common to share trades. If I like selling December vol and manage to get a big allocation on the trade, I might give some up to my like-minded buddy who was busy yelling at his clerk outside the pit. He would do the same for me.
- Every day is an interview
You are watching each other, sizing each other up, looking to hire or maybe get hired. You are watching and learning how the best traders were interacting with the broker as well as each other. Who’s smart? Who’s clever? Who is someone weak, raw, or exploitable? Whose someone you wouldn’t want to physically fight for their spot in the pit? Physical real estate in the pit was not assigned but earned through an invisible consensus of respect or even physical force. Go ahead, try to move me. Standing close to the brokers on the top step of the ring…that’s Central Park West. Down in the soup with the newcomers…might as well be in NJ.
- The information game
What can I share that isn’t too valuable but sounded valuable? There’s the constant sandbagging about what pits had edge. There could be 50 stinky dudes crammed into a pit the size of an airport Starbucks and if you asked them how the trading was in that pit they’d say gravely, “it sucks in here, nobody makes money”.
Here’s a veteran move — sniffing out a disgruntled market maker at a large firm. Perhaps a young trader upset with their bonus. They might trade info for acceptance. They are dreaming you’d hire them (somehow oblivious that a willingness to divulge secrets is not a quality you advertise to future employers).
The proximity to your competitors in the pit was an opportunity to learn faster. For example, if I hear the Citibank traders talking to their Clearport trader on the headset and then aggressively hitting a bid in the pit, it’s safe to assume they got an exclusive look at a deal that implies vols are lower. (This is why traders usually cover their mouths when speaking into their headsets. Just like NFL coaches do on the sideline when talking to their upstairs booths.) In fact, seeing your competitors with headsets or “hoots” in the first place tipped you off to the possibility of inter-market arbitrage.
Another strategic example. Suppose there is a SIG trader in your pit. You will watch what they do because you know they see all options flow globally. If they are suddenly the best offer in your options pit you can adjust your opinion of fair value lower, both leaning on their offer and knowing their broad access means they can see moments into the future. Go deeper. If SIG was a seller of BBH vol you might ping your market maker camped in the DNA (Genentech) crowd to see if Susq was trying to leg correlation trades.
On the floor everyone loved the Timber Hill traders. Timber used their tentacles in every market to feed a brilliant cross-sectional vol model (the “box”) that supplied each of their traders with a fair value for every option. In doing so, they also removed discretion from their traders. So every other market maker in the pit came to see Timber’s undisguised behavior as valuable market intel to calibrate against their own opinions. You could “lean” on their markets to “free roll” on their transparency.
[The Timber model optimized for holistic edge/risk targets but ignored the role of negotiation tactics to maximize individual fills. It was a top-down tradeoff that was the antithesis of the SIG poker style. This is not a knock against it. They systematized a different strategy with clinical precision. In fact, seeing how there was many ways to win was one of the beauties of being on the floor. To demonstrate the philosophical difference consider the following scenario:
If an option was worth $1 the Timber trader would always make a balanced market say .95 bid, offered at $1.05. While a trader with discretion, might in anticipation of a sell order make the market .90 bid and offered at $1.00. Why? Expected value…if the order is any more than 50% to be a sell order than you will make more money on a .90-1.00 market than a fair market of .95-1.05.]
The Twitter Pit
Learning from watching your competitors is common in business especially public businesses. Same in sports. Maybe not at first but everyone eventually gets smarter when they watch Belichick go for it on 4th and 2 from his own 40. Everyone got smarter when the first baseball manager shifted the defense based on the batter’s tendencies.
The public has the opportunity to learn from these strategies that cannot be hidden. (The Patriots practiced the pass defense that was disguised as a goaline stand for the entirety of the 2014 season only to use it once — on the last play of the Super Bowl, leading to Malcolm Butler’s interception of Russell Wilson to seal a Pats victory. They intentionally hid the play all year understanding the power of its deception should not be wasted until the stakes are sufficiently high.) I miss the multitude of learning opportunities that were strewn all over the trading pits. I miss hearing and seeing the competition with my own senses.
Luckily we have Twitter. Twitter gives me the same sense of a cooperative competition. You can spend parts of your day shooting the bull with people tied together by the same callings of opportunity and learning. You are watching the tactics people use to build their online businesses. You are seeing how accounts posture and market. You can watch debates on mutuals’ timelines. If you think about the floor dynamics I presented above, see if you can spot the analogies as you browse Twitter. They are everywhere. Who’s subtly or not-so-subtly angling for their next job? Whose bartering commoditized info that sounds good in exchange for valuable followers? Who relies on brute force? Who is the equivalent of the dishonest brokers playing the brazen quid pro quo game?
It took me awhile to realize it, but Twitter fills the void I left on the floor. There must have been a time when the end of the floors seemed unthinkable. That’s where we are with Twitter today. We’ll see what happens, but in the meantime…enjoy it.