Monday, September 25, 2017

Lessons From an Option Seller

Victor Niederhoffer is a famous option seller. According to Wikipedia:

Niederhoffer studied statistics and economics at Harvard University (B.A. 1964) and the University of Chicago (Ph.D. 1969). He was a finance professor at the University of California, Berkeley (1967–1972). In 1965, while still at college, he co-founded with Frank Cross a company called Niederhoffer, Cross and Zeckhauser, Inc., an investment bank which sold privately held firms to public companies. This firm is now called Niederhoffer Henkel, and was run by Lee Henkel (who died May 30, 2008), the former general counsel to the IRS. Niederhoffer pioneered a mass marketing approach in investment banking and did a large volume of small deals at this firm. He also bought many privately held firms with Dan Grossman, his partner during this period.

As a college professor in the 1960s and 1970s, Niederhoffer wrote academic articles about market inefficiencies, which led to the founding in 1980 of a trading firm, NCZ Commodities, Inc. (aka Niederhoffer Investments, Inc.). The success of this firm attracted the attention of George Soros. Niederhoffer became a partner of Soros and managed all of the fixed income and foreign exchange from 1982 to 1990.[15] Soros said in The Alchemy of Finance that Niederhoffer was the only one of his managers who retired voluntarily from trading for him while still ahead. Soros held Niederhoffer in such high esteem that he sent his son to work for him to learn how to trade. Read more

His trading strategy provided high returns for more than 20 years. However, he suffered a huge loss in 1997.

…reward comes with risk, and Niederhoffer embraced risk in ways that would eventually become costly. He got caught leaning the wrong way when the Asian financial crisis hit in 1997, all but completely wiping his fund out. But he slowly rebuilt, and once again amassed another fortune, only to see this capital pool destroyed by the financial crisis of 2007-09.

Bloomberg recently interviewed Niederhoffer.

Niederhoffer is a brilliant and fascinating character, a study of rich contrasts. He is a nationally ranked squash champion, and former Berkeley professor of finance and statistics. He is an undeniably talented trader, except for that small issue of occasionally blowing up and getting wiped out.

I am not sure that he fully accepts responsibility for his various disasters. His trading record is akin to setting the track record on the straightaways, only to crash into the wall on the curves. Still, he teaches an important lesson for any trader. As revealed in his first book, “The Education of a Speculator,” the risk-embracing style that created his first fortune comes with some caveats. Read more

Click here to listen to the interview.

Is shorting volatility a dangerous game?


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