~100% Returns in 2025, No Losing Year Since 2008: Erik Smolinski on Edge for Retail Trader Edge

0:00 They're really will always say, it's really difficult to find edge. And the irony is it is not. The problem is it just doesn't look the way people want it to look. >> Eric Smilinsky started off splitting wood and selling Christmas trees to help his single mom. Now he manages risk at a hedge fund and trades his own book. >> The market doesn't care what you want. It doesn't care if you have a small account and you can only afford verticals. >> Last year Eric returned close to 100% [music] and since 2008 has not had a single losing year. >> It's easy to blow yourself up in a boring [music] fashion, but in a spectacular fashion is when you are completely misguided by your own success. One of the places I spend a lot of time as a newer options trader is in

0:47 the back alley cesspools of the market trading things that were disgustingly illiquid [music] because there's less competition there. >> Hey, when I look at the back end of our YouTube statistics, I can see that only around 25% of you guys are subscribed. And I'd like to ask a favor. If you like the content we create and you want to help us grow this show, if you could hit that subscribe button, I would really appreciate it. I promise that in return, I will do my best to give you guys the best content we can with the best guests and best interviews we can do. Thanks and back to the episode. >> Thank you so much for coming on the pod. >> Pretty easy to make my way here. Thank you for having me. Looking forward to chatting with you. >> You did close to 100% last year trading options. Talk to me about how you got here.

1:32 >> It's a bit of a mix, but last year's trading performance is actually one of the strangest things of my trading career. I started in 2007 and specifically last year, I was not really trying for that or any number. And that's the same thing for the 2 years before that which have been my best trading years literally over my entire life. It's one of the weirdest things. About maybe like 5 years ago I actually guided down my annual return target. And the reason, the thought process behind it was just consistency, right? Like I wanted to be able to have a good planning factor and consistently deliver, but I think the main thing last year that happened is twofold. First, there are a lot of thematic

2:19 opportunities that popped up that might not otherwise exist in a vacuum. We had a really weird year and markets were volatile. And in the derivatives world, you kind of need that. You need big movements one way or another in order to do things. So, that's the first thing is just being able to play along with those. And I would say the second thing to tack on to that is over time you stop attempting, to at least for me, dictate like what the market should be. So, this is the whole, oh, you know, markets can remain irrational longer than you can remain solvent, which is like, that might be the case, but it's also like a really egotistical position, right? It's effectively saying my position's right, everybody else is wrong and irrational.

3:05 I'm not so sure I agree with that. And a big part of what I've learned to do over time is just kind of take the markets at face value. If things are going up and I can see the general themes behind things are going up, I'm going to trade them up. Great example is something like Palantir. Palantir was trading at hundreds of PE multiples, things that fundamentalists would objectively say effectively can't happen. And even a normal person would look at it and be like, yeah, I mean, there's got to be a value cap somewhere, where is it? But for me, that's not the time to not trade Palantir to the upside because I think it's expensive relative. As long as it continues to go up, that's what I need for that specific idea. So, to sum up those two things, the first thing is just learning different kinds of themes

3:51 and volatility-based ideas that you can put on. You just need movement. And then the second thing is just accepting the market as what it is and then doing your absolute best to interface with it. The mistake commonly is like, "Oh, I'm an options trader or I'm a stock trader or I'm a futures trader." And from a retail trader lens, my response to that is always like, "Don't be any of those. Just be a trader and then trade the things that make sense at that time." And that's effectively what led to that and again, funny enough, the two years before that, which have been absolute blowout years for me, they've all been under the umbrella of I'm not actually trying for a certain set of performance. I'm literally just focused on implementing

4:37 my ideas and my strategies. >> I would liken trading um and especially options trading to making a you know, series of bets. For you, what sort of things are you looking for when making one of these bets? What sort of setups? I don't know. How do you think about that whole problem? >> Yeah. So, I normally think of the market in the context of market effects and what I refer to as profit mechanisms. So, you can have very observable market effects. Take for example, variance risk premium, VRP, really common in the options space. And funny enough, for like retail traders, it's something that you spend some time with, but there's a lot that goes into doing that well. But if you take for example something like VRP. If you take the time to understand that as

5:23 an effect, why does it exist? What does the persistence of it indicate and mean? How does it behave? What does it generally look like, right? I call it profiling the market effect. Then you can take that market effect and turn it into, again, a profit mechanism, which is something that I actually can monetize. Because there's actually a lot of market effects that I can see that once you include things like friction, slippage, fees, I can't actually monetize it in production. It's just not viable. So that will just remain as a cool market effect, something I'll keep an eyeball on, but not something I can actually trade per se. So it's looking at the market and finding those. The funny thing, this is

6:12 literally one of the funniest things I think about the market is everybody will always say, "Oh, edge is so hard. Oh, you you know, like it's really difficult to find edge." And the irony is it is not. It really is not hard to find edge. But the problem is it just doesn't look the way people want it to look. Because you can find edge in variance risk premium, effectively taking on a risk premium. You're just not going to get Lambo money this year with that, right? It's the kind of thing that you just have to grind out over time. It's going to give you a modest return, but it's not that sexy. So just first couching your expectations and being like, "Okay, I'm still going to look for better risk-reward opportunities and stuff,

6:58 without a doubt. But I think acknowledging first just what the market is and identifying market effects, then profiling those, and then it figuring out how you can optimally take advantage of them for your book, and then just sticking with that, rotating through things as you can. That's effectively how I think about it. >> If you're a student who wants to work at a great trading firm, listen up. Our brand partner, Onix, the largest oil derivatives trading firm in the world, is hiring junior Rust developers. They're opening this up to people who haven't written a line of Rust in their lives, because they'll train you from the ground up. From day one, you're on a small team working on a real projects, learning from senior engineers who built the systems. If you're self-taught with

7:44 serious projects to show for it, apply at the link below. >> And do you discretionarily choose which VRPs you want to trade? And so, I mean, just generally, uh momentum works on a long enough time horizon um almost every year in my in my opinion. Value well as well. And would you say that the core of what you're trying to do is figure out which one of those or which one of, you know, the the a broader set of them will pay in the current regime? >> This is literally exactly it. It's trying to figure out what fits well now because it shifts a lot. Like right now, risk premium is not good, like right now. It is a a really difficult trade to come up with. And realistically, a lot of

8:29 this year, risk premiums have been really hard. Again, think of the idea of a variance risk premium, right? The propensity for implied volatility, forward-looking vol, to be elevated relative to realized volatility, what actually happens, you know, in past. And we have a really interesting environment where there's a lot of news that comes out. And a lot of that news can move the markets pretty good. I actually have a couple profit mechanisms built around news effects. And we are at a massive standard deviation move off of what like a baseline news-driven environment looks like. So, just more stuff happening. What that means is, in the context of risk premium, that's kind

9:16 of difficult then to trade. If you think of the Iran conflict, you know, cuz it's not a war, apparently, for us here, you know, the Iran conflict, the Iran war, it's first not happening, then it's happening, then it's not happening, then it's happening, then there's actually bombs that drop, then the strait is closed, then the strait is open, and on, right? We all know how that went. It's literally like hot, cold, on, off. And for the first what, 4-6 weeks of it, the market would react to each of those. Now, the market is kind of in like the the battered spouse syndrome. They're just numb to it. And it's just like, yeah, okay, the strait's closed, the strait's open, who knows? Right now, there's a blockade on the blockade, so whatever that means.

10:03 We're at the point where the market is just kind of like past that. So, I think in general, though, there's some things that work really, really well in markets like this. And then there's stuff that works really, really well in markets like last year, the year before, and so on. So, it's all for me, it's all about just tracking all these different profit mechanisms and saying, okay, like, where do I move my chips today? What seems to make the most sense? >> And do you do it on a sector basis as well? I mean, I imagine you were in semiconductors in order to generate such insane returns. >> And trading derivatives of those. Going to get your thoughts. >> Yeah, for sure. The So, if anybody is interested in some like basic edge, again, it's free game. You can go to a

10:50 website called SSRN. It's the Social Science Research Network. It's just a repository of a ton of research, white papers from all different sources, colleges, like, you know, where where you're at and whatnot. People doing, you know, their dissertations and whatnot. Tons of research. You can go in there and look at something called um sector rotation. And that's literally what you're describing there. We're undergoing fascinating sector rotation right now today with industrials doing what industrials is doing. So, if you can catch things as they begin making these really interesting moves, it just becomes a fantastic vector. Now, it's all based on your perception and your relationship with risk though because if you're

11:36 looking for bigger moves, bigger volatility, a lot of times you can't do it at the sector level even with a decent amount of leverage. It's just not going to really produce that great of a return. So then what I normally would do for that kind of thing is find the leaders within the sector. Then even that starts to differentiate more between market cap size because a lot of times if you're looking for things that are having much bigger moves, if you're doing this in mega caps, only enough you can still get massive moves apparently. Stuff like Micron and whatnot up like a thousand percent. But you know, that anomaly aside, most of the time you have to spend a little bit of time in the smaller stuff because they just have more upside. So then you can kind of just ratchet your way around this risk profile and this risk diagram to figure

12:25 out, you know, one, what are you comfortable targeting? And then two, at what level of volatility cuz there's a lot of different ways that you can target it but that's literally exactly right. That's a that is a actual pretty big part of my overall book is just attempting to find what I refer to as just market leaders and laggards and I'm finding stuff to go long to the upside and then I'm typically trying to find at least some type of stuff to add some short deltas to the portfolio. Because I I don't like being like I'm normally leaning long but I don't like only being long because obviously there's pretty good money to be made when the market makes pullbacks. But objectively based on you know, my my

13:10 performance and whatnot, I'm I'm definitely better at the upside than the downside. The downside sometimes I struggle with that one because the the profiles there are a lot different sometimes. >> And so once you've identified the leaders and the laggards, how do you express that belief? As in on a granular basis. Can you walk me through that? >> Yeah, so I could do some sort of cross-sectional analysis. So, it's both a time series and then looking at counterparts, trying to find things that look really good. When I find the things that seem to look really good, I'll generally either it kind of depends on if things are already in a pretty big uptrend or if things have started to slow down a little bit. But, what I'm normally

13:57 looking for are things that have been consolidating for a little while, at least at least a few days, ideally longer. I'm looking for things that have been consolidating, showing relative strength to the rest of the sector over that duration. And then as I start to see things, specifically the broad sector breaking out, that's normally when, you know, rising tide lifts all boats, you can typically find some pretty good movers in there that have just been held down by the market and the sector in general. And then for those, it really depends on what stage of an up move we're in. If it's an early stage, meaning I'm catching the breakout pretty early, then normally I'll either run things like synthetic longs, I'll still add some convexity via long calls

14:43 that are really based on the options chain for the underlying. I think a really big mistake, especially retail traders make, is they'll say like, "Oh, I want to trade options. I'm going to pick the strike based on where I think the thing is going to go." It's just not how it works at all. So, normally what I'm doing is observing the underlying itself, trying to find where I can find liquidity, but most of the time I want to be a little bit further out in time. And the reason why I want to be further out in time is just because a lot of the forces for specifically long options like that, I actually want to negate a lot of them. So, it could be anything like a really common play, for example, be like a 90-day ratio call diagonal. What that looks like is the long leg of the spread will be further out in time, so 90 days to expiration or more.

15:31 And depending on convexity that I'm looking for, it'll either be like about the money, like a 50 delta or so, or it'll be way in the money up to an 80 delta. Really just depends on the kind of move I'm expecting to see. And then what I'll do is in the front, so near-term, maybe like 2 weeks out, 3 weeks out, 4 weeks out, I will sell at a ratio to the longs calls so that I can subsidize the holding cost for the longs without sacrificing my upside. Because for those that don't know a typical diagonal, it kind of looks like this. You know, you start at the the bottom, it slopes up, it makes a little TP, and then it comes all the way down. So with a normal diagonal, you literally can be too right. If it goes in your

16:17 direction too far, you literally can start losing money again, which always made me just really upset because I was good at finding things that were like making money, and then all of a sudden I'm losing money on this idea. I was like, this is insane. I am completely screwing this up. So then that's when I started running ratio diagonals, just creating a ratio between the deltas so that that doesn't happen. And then I have uncapped upside profit potential. Stuff like that. >> How did you get into learning all this? Because I remember we were talking on a call last week, and you were talking about how you were in the in the military, you learned started in high school. You walk me through the story of it? >> Yeah. So it was And it's funny, too, because when we were talking about it, I actually don't normally go that far in a

17:04 detail just cuz it it feels like honestly like a really common story to me. And then you expressed a different opinion, which I I actually thought it was kind of funny. Because I I grew up with a single parent. I had a mom, she was a occupational therapist. So, and she was a a contractor for the city. So, that means like no retirement, nothing like that. She worked at a public school system. And anybody that's in that scenario, you know that that career doesn't necessarily make tons of money if much at all. So, I grew up pretty low income. As a result, there was also really not great spending habits. And I really enjoyed working. I would do odd jobs as much as I possibly could. I used to split a lot of wood, move shale,

17:50 sell Christmas trees. I always make a point to tell people that if you're looking if you're like younger, looking for a good gig, go sell freaking Christmas trees. Because that holiday spirit, the tips are awesome. Just be jovial, have fun with the people as you're putting the tree on their car. I'm telling you, man, like I used to come home sometimes and my mom would think that I was like selling drugs. I was like, no, like these are just people that are happy and they just gave me a really nice tip. It's insane. So, pro tip, there's some free edge there, just straight off of sell Christmas trees. But, I was doing all of that and I had a teacher who was a it was actually an ROTC instructor that I spent a lot of time around because like I knew my dad

18:37 and stuff, but I didn't have, you know, like that present father figure. And he kind of started to fill that role for me. And he saw that I was working a ton and he effectively just said like, "Hey, what are you doing with your money?" And I said, "I'm just kind of saving it, trying to pitch in where I can." And he said, "Well, have you looked into investing?" And that is literally the first time I had ever heard that word in that context in my life. And he explained this idea of like compound interest. He just explained it as, you know, your money grows and that's effectively it. I was like, that sounds great. That sounds like a really good thing. So, I just started doing homework on it. I went to the library and started poking around. And that's when I started down the rabbit hole. One of the interesting things I've learned about myself, I have

19:24 a highly obsessive personality. As soon as I find something that I like for some reason, I think there's an opportunity, anything like that, I I literally go all in. And it's I've kind of been like that a long time, but as soon as I realized, especially with something like money and markets, that seemed like a really good way to go. And that mentor, that high school teacher, he made it really clear that if you start that stuff early, it helps you a lot. I was like, well, I know this guy, I trust this guy, he typically gives good advice, I'm going to do that. And I started that. Then, you know, like most young adult males, or I guess young really young adult males, I was super duper impatient, and I

20:11 wanted to figure out a way to do more. And especially as a new trader, sometimes you make the mistake of thinking like if you do more, you'll make more, which maybe in the long run, in the beginning, if you do that, maybe, you know, your learning curve helps you and whatnot. But, in general, I wanted to get more involved and see if I could speed it up more. And that's when I actually started getting way more into active trading and then specifically derivatives. Was coming across a couple books, it seemed super interesting to me. And I started, you know, with a super small account. And I was absolutely hooked at the idea that I could put my money in this thing, if I'm right with an idea, I could make X amount of my capital back without doing any

20:57 additional work, just that investment. And I have completely focused my entire like life force on that for a really long time. When I was in college, I The only reason why I was able to go to college was because of Marine Corps scholarship. That same mentor is the one I was going to enlist in the Marine Corps like my brother did, and he was like, "Well, you have like a really good set of skills." He's like, "You should go be an officer." I was like, "Well, they have to go to college. I can't go to college." He's like, "Well, just try for the scholarship. You have nothing to lose. If you don't get it, then you go enlist." Got the scholarship. The entire stuff I did in college was my school, ROTC, and trade. That was it. All the time. Thursday night, people are going out for Thirsty Thursday, which I still would

21:43 partake periodically. Most of the time, I wasn't. I was home trying to crack this nut, trying to learn more about this thing. And the irony is actually it not that long after led to the largest percent drawdown that the account experienced still to date, which is great. But, as always, I'm sure you've done enough of these to know that that is just part of the game. That's table stakes in order to figure out your way. >> What were some of the strategies you started off running versus what you're running today? >> A lot of verticals in the beginning. A lot of verticals and a lot of spreads. And for for bad reasons. There are places to run verticals, iron

22:28 condors, and stuff like that depending on what the market looks like. But, in general, you don't want to trade verticals simply because you don't have enough money to not do that. Right? Like, that's a big part of what it was. Just limited capital, had to trade verticals in order to be able to do anything. It's a terrible reason to trade verticals, and that's a big thing that I leaned on early on. And with respect to stuff that I did early on that changed to what I'm doing now, no many verticals. It's like very rare actually that I'm trading spreads. Most of what I'm doing are different kinds of naked options that they're referred to. It's not no spreads. There are time for

23:15 spreads and there are are are times definitely that I'll implement them, but it's far more the exception than the rule. That's probably hands down the the biggest shift because there's a there's other like massive misconception with traders. This is again retail focused, but there's a massive misconception where they'll think that like you know, it's only hard cuz you don't have a lot of money and then like it magically gets easy when you have more money. It's like I I don't understand that at all, but there are genuine benefits to having more capital, right? Economies of scale, portfolio margin, all that stuff is useful, but none of them inherently build edge. You still have to have something that you can do. So, really what I'm able to do now is

24:00 just attack things way more efficiently using things that make more sense for the idea that I'm trying to trade. A great example like we're talking about before, sector rotation, leader breakout, something like that. Now, I can just buy the 90 DTE or whatever. I buy whatever options that I want in order to attack the idea, whereas before I'm selling a put spread or I'm buying a call spread. And that's kind of it. Then even in those scenarios, anybody that's familiar with verticals like that, they're risk defined, but also profit defined. Not going to make that much. So, you have these ideas that are playing out, but then you're not really participating. It's a actually a pretty

24:47 big gap with those. Hands down the biggest difference from what I used to trade as far as structures to what I trade now. >> What are some things you wish you knew when started. >> A couple things really strike me. The first thing is probably the hardest one because it's the most difficult to wrap your mind around. So, it's something that I knew, but I wish I accepted it better and implemented it, which is like in the beginning don't worry about the money. Which is the craziest thing to hear. That's the only thing that matters in the beginning. It's the only thing that you care about because you have no money. You're like, I I want the money. So, it's it's the polar opposite. Again, I've heard that before. I kind of knew

25:32 that that was important, but there was just no way that my mind was like able to adopt that and I really wish it could have just because like much of what you're doing in the beginning is laying a foundation for processes that ideally if you build well, will serve you over the rest of your trading career. And you just kind of have to accept the fact that like your beginning account balance might move ever so slightly up, but as you start to get more capital through saving, getting better at trading, that's when things start to go quite parabolic. And they can go quite parabolic. But it's really difficult to get to that parabolic step if you're constantly trying to rush to it. It's a great example in something like jiu-jitsu for

26:18 anybody that's a practitioner in in any of those kind of sports. With something specifically like jits, as a white belt, a lot of times you're like trying to focus on how you're going to tap somebody out, right? How you're going to like win your sparring match or your roll with somebody. And the irony is like the only thing you really should be worried about as a white belt is not getting decimated. Like that's it. You should maybe know of a couple very basic attacks. That's it. You're not worried about your passing game as a white belt. It doesn't matter at that point. Although it feels like it matters, but it doesn't. And the reason why it doesn't is not just because you have to have really good defense, but it's actually if you have really good

27:04 defense later on, it massively increases your offense cuz you're not afraid. If I try to get something and I miss for whatever reason, I don't care because I know how to defend and maneuver around to reassert good position. That doesn't occur to you at all as a white belt. You're just thinking how can I tap out this guy on this roll? The exact wrong focus. Same thing with trading. If you're so focused on the money in the beginning, you're just going to focus really on the wrong artifacts that don't serve you long-term. That hands down the biggest one and it's really really difficult to accept and onboard when you're at that point, but I

27:49 cannot overemphasize how important that is. We have a saying in the military, slow is smooth, smooth is fast. It's exactly that. It might feel slow, it's going to be way smoother, and in the long run, way quicker. >> What are some of these specific artifacts that retail traders who want to trade options in a thoughtful way need to focus on? >> Some of the specific artifacts retail traders should focus on early on is first that options have no inherent edge. There is no edge in trading an option. There's simply a vehicle and realistically a pretty complicated vehicle. That's the first thing, just accepting that there's no edge.

28:34 The second thing is that the market doesn't care what you want. It doesn't care if you have a small account and you can only afford verticals. That doesn't make verticals good. It doesn't care if you think the market is irrational longer than you can remain solvent. It doesn't care. The point I'm making is that second part, you kind of have to accept things as face value to then get you to the third spot. The third spot is thinking of the market in the context of market effects and profit mechanisms first. The problem with new options traders is a lot of times they learn vertical spreads, they learn their long calls or whatever, and they just immediately want

29:20 to go implement those places. But the entire framework that leads to you figuring out where to implement those tools is completely broken if not completely devoid. The way that you can com- like easily completely flip that on its head is force yourself to start a written trading plan. Not one that Claude made for you, not one that Codex made for you, one that you wrote with your own brain. And it doesn't have to be anything crazy, it could just be a word doc. But effectively, the way to think of this trading plan is it should document exactly how you think you're going to do things. And what you're going to find is you don't have a lot of answers, a lot of them. The thing is it's way better to

30:05 find that out in the trading plan than when your money's out there. Cuz the money will take Mark will take your money super quick. Figure it out in the plan. And people don't like to do that, right? Because it's boring, it's not engaging enough, it's not moving fast enough. And there's a really easy way around that. Start a standard buy and hold portfolio. Imagine you were never going to trade, whatever you would put your capital into S&P fund, VLO, whatever, do that. Just put your money in there, let it work. It's working already. So it's not waiting on you to figure it out, It's already doing, generally speaking, what it should be doing. Then from there, focus on the rest of this general process,

30:51 specifically with derivatives, once you understand and look at the market through the lens of market effects and profit mechanisms, there's one other really, really important piece to this puzzle, which is developing a really deep relationship with options. Because it's really easy to buy a call in something because you think it's going to go up, but you're not even thinking of the implied vols that you bought to get that. You bought vol that's way too expensive, and then you don't actually make the money that you think you should have made. So, one of the other things is having a really deep relationship with options and derivatives in general. It's kind of like learning your tools. There's plumbers apprenticeships. There's welder

31:37 apprenticeships. If you're going to become a doctor, you go to med school, you shadow a doctor, you learn how they use things. Literally, when I went to urgent care to get my hand looked at, there was a newer person in there that was watching everything that was going on. The person that was actually doing the work was asking them questions. They should have the right answers. That whole thing, right? It's like learning your instruments in detail. And the reason why it's super important is because it's really, really easy to express an idea that might be good, but to lose money because of some factor that you didn't even think to consider. So, you could buy a call cuz you think something's going to go up, but you could then unknowingly grossly overpay for vol, which you could have fixed. You don't have to put yourself in an option

32:22 that places you directly in front of that cost. And then you might get your move, but then vol might collapse, and you were right, but wrong. That's easy to happen, and it's completely preventable. The way you prevent it, one of the most unpopular things that I talk about that I hope sometime it'll catch on, paper trading, bro. That's it. Paper trade. The problem is a lot of people are super undisciplined. And they'll say, "Well, I can't take it that seriously cuz it's not real money." And I I literally always chuckle cuz I'm like, "Damn, man, like I'm really glad that pretty much no other profession acts like that." Think of your doctor. Well, I never wanted to practice cuz it's not a real

33:08 patient, so what's the point? I'd rather you practice, bro, a lot. Practice a lot. A lot, a lot. In the military, in the Marine Corps, we train all the time. It's not super frequent that we're getting shot at with live fire during training. I'm super glad that we train, even though that's not the case. It's awesome. Really awesome. Makes you way more effective when you're out there, but retail traders, specifically, they they have this complete delusion that like trading is this super unique thing that's like uniquely challenging, super hard. It's got all these crazy things that make you special for doing it. And it's like, "Dude, it's just another profession with, if you think of it, most of the

33:54 stuff that you need to do for those other professions, that's what you got to do here." Part of that is freaking practice. But nobody likes to do that. So, that's probably like the next biggest thing you could do is get some discipline in your body and do the things that you're supposed to do. Not necessarily the things that are the most fun or that get your endorphins rushing or give you a dopamine hit, but the stuff that you actually need to do in order to make the thing successful. The last thing I'll say on that, and I really believe this, trading is interesting to me. It's super interesting to me. But I have forced myself to be completely desensitized. Market's up,

34:39 portfolios up, I don't care. Market's down, portfolios down, I don't care. As long as things are behaving as they should, I don't care. The stuff that I allow myself to care about is did I apply a process correctly as I'm supposed to? And then when I withdraw the money from the portfolio to go do cool things, then I can care. Then I can enjoy, have all the dopamine that I want when the cash is in my hand, and I'm doing the fun stuff as a result of the effort. But practicing is so underappreciated, and it's just because people are really lazy retail when it comes to trading, and it's a lot of times cuz of the complete

35:25 BS marketing that exists and leads them to think like, "Oh yeah, this is fast easy money." No bueno. >> And on getting deeply intertwined, actually rather, how have you trained yourself not to care about P&L in the account and separate >> The easy The most important thing you can do to train yourself and like really desensitize yourself to account P&L it's actually really easy. The first thing is in my paper trading I would always envision it as real money, and then I would have two paper trading trackers. It was mostly in like Excel and Google Sheets that I would use. And in those, I would have one that's my actual account size, and then one that's 10x the account size. So it would just

36:12 take everything from the first sheet in the second sheet multiply everything by 10. I would just get used to seeing those numbers. Just get used to seeing the numbers. Then the second thing that I actually found really easy is focus on nerfing the wins first. It's so easy to get happy after you have a winning trade. It's super easy. I got this right. I predicted it right. Blah blah blah blah blah. The problem is if you allow that, you're also probably the person that feels the lows pretty bad. Don't want that. So, I actually find it easier to nerf the wins first. Be like, "Okay, cool. This position worked. Why did it work?" Right? You can go directly into the postmortem. Figure out like what you did

36:58 well, what you can improve. And then the same thing with a losing trade, it's not saying like did this one occurrence make money or not. It's accepting the fact that everything you're doing as a trader is a representation of your ability to do things over time. Are you able to do something over time well? So, if you have one bad outcome, it doesn't mean that you did anything wrong. That's going to happen. That's the name of the game. And if you can accept that and say, "Okay, bad outcome, but I look at everything. I followed the process properly. This thing still looks generally alive in the context of the current market. Okay, I'll go do another one." And as long as you find the cracked infrastructure and the setup for it, you just go do another one. So, two

37:46 things. One, just desensitize your relationship with money. And then the second thing is a little bit of that exercise. Now, I would add a a third bonus item onto it, which is trying to do a little bit of analysis to figure out like who you are. Are you a risk open person or are you a risk averse person? I was a risk averse person. And it's because like, again, the way that I grew up, money was really scarce. So, anytime I had money, I wanted to do everything I possibly could to keep it. But, it's really difficult to money to let money grow if you keep a stranglehold on it. So, part of my project was acknowledging that fact about me and then trying to navigate around it. If you're a super risk open

38:32 person, you have a different problem. It means that you're not carefully thinking enough about what could go wrong, those details, and what actually might happen with your account. And sometimes it's cuz they think, "Oh, well, I'm actually not that worried about the money." There's actually somebody that I spent a lot of time chatting with that also creates YouTube videos that falls generally into that bucket where for a while they didn't really seem to care that much about money, which is okay. But the problem with that then is that's how you're assessed. Do you make or lose money in this thing? So, for them, it was literally about sensitizing themselves slightly to the money and acknowledging the fact that it is whether or not you are materialistic, not materialistic, none of that. It's

39:18 just how good are you at doing this activity and adhering to what you're supposed to do. So, for the risk open person, you have to sprinkle a little bit of that in. For the risk-averse person, it's the opposite. You have to start exposing yourself to risk and being comfortable with it. One of the easiest ways you could do that, put money in an account, the whatever amount of money you can afford to like literally completely lose, and try trading with that. So that you can completely detach from the capital that's in that. It's effectively putting it in and saying it's gone. But then using that to attempt to trade. >> More broadly, how important is one's

40:03 personality to the way they should be trading? >> I think someone's personality effectively dictates what kind of trading will work for them. There's a bit that you can trade and navigate around, but You and Sinclair and I chatted about this a while ago and I agree with his general disposition that trading is the kind of game where you really stand to benefit a lot more from leading into your strengths than repairing your weaknesses. You do have to fix your baseline weaknesses, right? Like if you can't manage risk, like yeah, you you got to fix that. But there's no amount of risk management that's going to make you money either. You have to speculate in order to do that part. I think

40:49 acknowledging your general propensities and trying to bucket them into things like is this something I can lean into and use or is this something that I have to mitigate in some capacity? A great example early on, I was impatient. That would lead to me trying to put on trades too fast. I would see something and then I'd be scrambling to put it on as fast as I can because I saw the price that I wanted and I had to have it right at that price. And then you put this trade on and then you realize in two days it has earnings. Not a part of the trade, you just put on a position two days before earnings because you didn't check. Why didn't you check? Because you were rushing. So to fix that, I needed a a literal hard stop. I forced myself to do

41:36 a straight-up paper checklist. And it wasn't crazy. I didn't have to like write an essay, but I needed to acknowledge that I was looking at each individual thing that I thought I should look at before entering before entering. And then once that became part of my process, then yeah, you don't have to do a freaking trade paper checklist forever. But I needed to really reshape that behavior pretty badly cuz that's a terrible behavior, especially when your account starts to scale in size. It's really hard sometimes to get into something, realize like you did something wrong, and then to try to get all the way back out. You take a pretty good haircut doing that. When you're smaller, you can get away with it, but it's something that you want to identify

42:23 and fix pretty quick. So, I would do my best to learn all of those propensities. What it requires being comfortable enough with yourself to not just sit there and think about how great you are, but to literally punch holes in how you do business, what your weaknesses are, and then figure out is this something that I can just true up pretty quickly by doing something, or is this something that I need a physical or some sort of process-based constraint to stop me from doing this thing. >> Are there any advantages inherent in being a retail options trader? And I ask that question with the context of um you look at the top trading firms, hedge

43:09 funds, it seems like the motes that they've created around information, around talent are not just prevalent, but you know, insane. And then on top of that, getting even wider, you know, with more talent, more resources, capital that gets more capital, that gets that gets more capital, that gets more talent, etc. How do you think about that? >> There are some significant significant benefits and inherent edges to being a retail trader. Not many. Most of the advantages are going to belong to the institutions, but just like the remora, if you're familiar with that, that's like one of the cleaner fishes that latches onto the side of a big fish and just kind of moves down. Just like those guys or

43:55 cleaner shrimp that literally go in the mouth of a moray eel to clean the inside of their mouth, and they don't get eaten cuz they have a symbiotic relationship. You figure out where you fit in. There's a really cool video from Warren Buffett a while ago that he was talking about how difficult it is. Everybody looks at Buffett's cash hoard. And they always say, "Oh my god, you know, he has all this cash. He's sitting in all this cash." One of the things he'll tell you is it's really hard when you're that big to find stuff to put your money in and have it be any sort of realistic percentage of your portfolio. Look at the size of the companies in his portfolio. He has He has positions that are point 0.04% of the portfolio that

44:40 are still millions of dollars. It's a big position. But it means nothing in the context of that portfolio. So, a couple of the specific advantages. The first one is your agility. You are able to be completely long at the first part of the day, and if you want, completely short into the end of the day. No reviews, no worrying about liquidity, no block trades, nothing. You can do all of that really, really easily. I would think that probably your biggest advantage actually lies there, in your agility, your ability to move between things. Another really big ability, though, is your ability to not trade. You don't have to quote markets. You don't

45:25 have to be in markets that you don't want to be in. Conversely, you can also play in markets that other bigger, more capitalized, more advantaged entities are not. Because stuff like liquidity. Retail traders to some degree have become liquidity snobs, where they think they need, you know, super, super tight markets for everything that they do. And it's better, and in general, you want that, but there is a downside to liquidity, way more competition. One of the places I spent a lot of time as a newer options trader is in the back alley cesspools of the market trading things that were disgustingly illiquid because there's less competition there.

46:13 And there's legitimate edge there. Now, again, sometimes it can be difficult to like really pick apart is this actually edge, is it just path, whatever. That's the other cool part about being a retail trader, it doesn't really matter. If it makes dollars, it makes sense. So, there's actually like a very legitimate handful of benefits that are really specific to retail traders. But, most There's one other one that I will mention, which is you can ride the coattails of bigger order flow quite easily. And the amount of money that you can make riding those coattails as a raw dollar amount can still be quite lucrative. You don't need to have these

47:00 really outstanding returns all the time in order to do quite well for yourself and build a solid portfolio and build a good nest egg. It can get to the point where you're making more than you need trading actually pretty modest stuff. So, there's a handful of edges that retail traders, or advantages I would say, retail traders have. Again, there's not many. The two biggest ones by far are their agility and then their ability to not trade when something doesn't look good. There's no imperative. >> Can you give me an example of how retail can ride the coattails of bigger order flow? Something specific. >> Yeah, so there's a few ways that retail traders can ride the coattails of bigger

47:47 order flow. Most of the time, you can generally monitor, again, with options markets it's actually a lot easier. But, even in equity markets, you can see it. When larger institutions want to build a position something, it generally speaking doesn't happen overnight. It's something that they have to build over some duration. A lot of times it's using things like VWAP orders. So, you literally can observe a certain period VWAP and track it. Just track it. For a handful of underlying that you just happen to be interested in. Then, you'll find at times when accumulation or distribution is happening for these entities that anomalies start to pop up. There's bigger orders that are happening

48:33 every single time it's this VWAP. There's a trade right there. Literally right there. So, there's bigger ideas that you can do based on known factors. Window dressing. It's a fantastic factor. It's the propensity that towards the end of the month a lot of funds are trying to clean up all of their speculative disgusting positions. They're unwinding a lot of their speculative equities and then they're onboarding safe assets like bonds. Definable effect. I can see it. I can measure it. And it's quite persistent. It's another thing that you can trade. So, you can literally look for the footprints of larger pools of money and ride whatever they're doing. Again,

49:21 you're not always going to make tons of money. Window dressing is pretty well known, so you're not necessarily going to smash it out of the park, but you can still do quite well with that as part of your book. So, there's two. >> Would you say that a good chunk of the way retail options traders can make money is by stacking all sorts of these different ugly imperfect edges that people know about? >> I hesitate because it's one of the things I really changed my position on recently. I think if you're a retail trader that's trying to monetize and turn this into more of a business over time, yes. I think it's actually really important to have multiple plays, multiple tools in your toolbox. I think though, early on it's a massive mistake.

50:10 And I think it's a massive mistake because you have so many things that you have to get right. There's so many things that you have to learn that if you're now spreading that across a bunch of different profit mechanisms that you don't know you don't even know that they're profit mechanisms. You don't know how to measure them. You don't know how to assess them. You don't know how to test them. You don't know any of that stuff. And then you just do that across a handful of things. It's kind of like half-assing six things instead of whole-assing one thing. I think of it more so as is like a new retail options trader it actually makes a lot of sense to just try to replicate known effects. Momentum, probably one of the best studied market effects that exist. Tons of profit mechanisms exist off of that one factor momentum.

50:56 I think simply trying to replicate some of the research you might find on SSRN with respect to your performance that's a great place to start. The reason why it's a great place to start is because there's guardrails. You know that thing's been studied. You kind of know what it does. Then if you start attempting to implement it and your results are wildly different, it probably means you're dorking something up and you need to go fix it. But you kind of have an answer key to help guide what you're doing. Because without that answer key to some degree, you're just guessing. You don't know what you don't know. You don't know what looks right. You don't know that the backtest you just did is grossly overfit cuz you don't know. And you end up putting on something that looks really, really good. It wins 90% of the time,

51:42 but you don't fully understand the tail risk of it and then it blows you out. So, I would take the inverse of that actually. I think focusing on a really well-known documented market effect and attempting to replicate it to get your process in order is where I would start. Then, once you can do that, that's exactly what I think you could do what you're talking about, which is start shopping, start adding more things. Have you gone into options at all yourself? >> Not much. >> And why? >> Because I guess in some regard I'm lazy to study the intricacies of them. And I prefer viewing things simply as um an equity. So, just it's very easy for me to

52:28 understand why Apple is up this on the news. And I just haven't myself gone deeply into studying the different ways to express different bets and whatnot. >> Well, maybe that's a project for you and I to work on. That could be super fun. But, the the basis for that is exactly correct, right? You essentially said, I want to understand the profit mechanism well. And as soon as you add derivatives, there's now a bunch of other conflating factors that can be really confusing. That's exactly correct. I actually think that as well. I think for new options traders, it makes way more sense to just understand base market effects that might have nothing to do with derivatives, nail those down,

53:14 and then figure out how to fit derivatives to it. Otherwise, most of the time it's just force fitting stuff that doesn't necessarily make a lot of sense. >> 100%. And I guess I have a question about those traders starting out. Um let's say there's someone watching this podcast and he's trying to figure out step one. He heard your advice about replicating papers. If there was one paper that you think someone should start out and replicate, which paper would that be? >> I think it's actually a book more than a paper. And it's just because the book goes into multiple papers. There's a guy that I'm pretty good friends with named Wes Gray. And he actually runs Alpha Architect. It's a

54:00 huge ETF provider, literally billions of dollars. Super cool dude, but he was a Marine vet, by the way. And he really likes momentum. He put together a book called Quantitative Momentum that pretty much takes all of the existing research about momentum, buckets it into a book, and shows you all different kinds of it and different ways that you can attack it. That's where I would go because it also is generally pre-vetted. A big thing when it comes to analyzing research, that's another skill. It actually takes some time to understand the angle of the researcher. What is their motive incentive? What are they trying to prove or disprove? How does that influence the way that they do their research? Are they doing proper research and how? Is

54:48 there in-sample, out-of-sample? How are they doing their out-of-sample walk forwards? How did they do their back to Like all of those questions have to be answered in detail. A lot of times what you'll find is research is really difficult to do well. And a lot of people on SSRN will have different kinds of incentives that can be really difficult to pick out. That doesn't make it bad. It's still a fantastic, a really good place to start, better than Reddit. But those small things can add up over time. So, I'm obviously not sponsored or anything by Wes, but that that literally is probably one of the best possible places I could think because it gives you a ton of different ways to look at momentum. And there's just a pre-vetting process that Wes went through with what

55:35 he's looking at cuz obviously he's attaching his name to the book, and super important to his reputation to kind of get it right. >> And how do people build up a discretionary, call it gut feel, for under for understanding quantitative factors that is so important for options trading? >> I think building up a discretionary feel for any trading, not just options trading, comes from observation and noticing deviation. Again, the funny thing about options trading is that it's not unique in pretty much any way. It's the same thing if you think of sports. I don't really watch any sports, but I played rugby. It was really easy for me to see

56:23 if something wasn't right in how the team was set up, or if they were leaning, favoring something, so that we could preempt our defense to address whatever that thing is. Same kind of thing happens with a football quarterback. Somebody like Tom Brady has made it really clear he's not the physical stud of the group. He's very average in terms of his physicality. But his superpower was studying the game really, really well, and knowing pretty much anything that the other side is going to do as they're doing it, and then position his team properly to address that issue. It's the same exact thing. I think with trading in general, not just derivatives, you have to build a reputation for

57:10 meaningful observations. Meaningful observations. When I say meaningful, it's as part of your trade log, so you have a trade plan that's kind of like your written documentation on what you think you're going to do, and then your trade log is where you track it. A really simple trade log to start with is nothing to do with any trades. It's just go in there, do an analysis of the market on a certain day, and guess what's going to go up, what's going to go down, and track it all. Add a couple notes as to why. Really important part, if you're going to do this, by the way, is just think a little bit further down the line. Try to make it so it's easy for you to do data analysis on it. It's like impossible to do good data analysis on a notes block where you put all of your research in. You can't do anything with that. So,

57:56 instead, think of ways that you can do research. So, for example, if you're looking at moving averages, have different columns for moving averages, and if you're doing widths, or if you're doing spot price relation to it, whatever, have something where you can just put in a number, so that you can do analysis on it. Otherwise, you just have a ton of notes that are really annoying to do any sort of quantitative homework with. That's a really easy way to start. >> On those observations that you mentioned, how do you make sure you don't learn the wrong lesson? And I ask that with the context of the regime we're in right now, who knows if it'll persist. Think about a time like dot com, or you know, you can either get burned too burned too hot to the point where you

58:42 never want to take risk again, or be in a market where everything seems to go up, and you can close your eyes, throw your dart at whatever, buy it, and it goes up. >> So, there's a few things you could do to make sure that you're training your gut feel effectively, and it's kind of like a building blocks stair step approach. It's again, another thing that I've learned from my time in the Marine Corps, which is a lot of crawl, walk, run. Before you want dudes doing a live fire range, you want them doing a non-live fire range, maybe with blanks. And before they're doing an actual range movement with blanks, they're going to practice squad maneuver in a just football field, so that you can see how everybody moves. And before they're in the football field, they're learning their weapon systems so that they know

59:29 where their PDF is, principal direction of fire is, where their base of fire is, and where the maneuver element is, and so on and so forth. The point that I'm making there is you kind of start small and then build over time. So, the way you start small is like I explained. The way that you begin building and honing that intuition over time is by tempering it and expanding your observation window to look at prior time. A lot of time it's doing things like backtesting. And seeing, okay, interesting. I notice for this opening range breakout thing that if I use the first 30-minute candle and then I trade it in this kind of way, this is what that normally looks like, which is kind of interesting. Then you can say, well, what does this actually look like back in 2007? What does it look like in the bear market for COVID drop 2020? And go look

1:00:17 at it there. But, I would start simply first and then build to that over time, and then you can get more complex. Then you could do like synthetic stress testing, meaning you can train a data set or a walk forward data set or a Monte Carlo sim on a prior bad frame, but amplify it. Good example is the COVID bear market. COVID bear market was super interesting because it happened really fast. Then the duration of the bear market was anomalously short, few days, before it started rebounding. So, what you can do instead is you could simulate, well, what if that rebound didn't happen that fast? What if that rebound actually took the normal term of 298 days?

1:01:02 What would have looked like then? What would strategies look like during that kind of environment? So, you can actually synthetically build that kind of environment so you could look at it. >> We've talked a lot about what people can do to make their the start of their trading journey go well. What are the things you they can do to make them a disaster? Like do this and you will guaranteed blow up, lose all your wealth, you know, just have it be the worst possible outcome imaginable. >> The easiest way you could guarantee blowing yourself up, and I would add in a spectacular fashion. Cuz it's easy to blow yourself up in a boring fashion, right? You just yolo into something you know it's super risky and then it doesn't work out, right? Like that's

1:01:48 easy to do. But in a spectacular fashion is when you are completely misguided by your own success. You put on a trade that made money. You put on another trade that made money. You put on a trade that started lose money. You cut it at the time that you thought was right. You nailed that. And you build your account up. And you've done a great job. It seems like you really got this thing dialed in. So then you start sizing stuff up. And then the market invariably will throw something you've never seen before. You will completely mess up how you're supposed to respond. If you're lucky, you'll just lose a limb. Most people freeze at those points and invariably blow up their account.

1:02:35 It's a really good way to do it. A good way to do it is do something that you think works well, something that you don't really understand, and start scaling it before you understand how it behaves more in detail, and then freeze up when things start going poorly. Good way to blow your account. Really really high probability of doing that, too. >> Final question. We've talked a lot about your journey, about how retail can succeed in options trading. I want to go back. What is the foundation of edge in retail options trading? What are the advantages someone needs to exploit in order to win? >> I think there's a few different foundations of edge. A big part of it is

1:03:22 just logically thinking through why something exists. For example, risk premia. Why does risk premia exist? How can you logically reconcile the fact markets are pretty efficient. We know efficient market hypothesis exists. There's three forms. A lot of people don't know that. They just think efficient market hypothesis, but it has three forms. And it most closely exhibits semi-strong, not strong. And if markets though are generally efficient, then why is implied vol typically overstated relative to realized vol? Why can't they just price it better? Probably could. But what it's telling you is that there's a risk factor that the other

1:04:08 side of the trade is essentially demanding be there. That's something if you understand it deeply enough that you can monetize. I don't like equating it directly to insurance cuz it's not the same and people conflate them. But it's kind of close to insurance in a way that you're generally selling something that's overpriced. And every once in a while you're going to get kicked in the nuts. That's part of being the insurer. But if you can manage your book well enough, you can monetize that over a long run. That's the the crux of retail's capacity to identify and build edge is to observe market effects, observe profit mechanisms, but understand them deeply.

1:04:55 Why does this thing exist? Why does momentum exist? We know that the market is again pretty efficient, so why does it exist? Well, we know that there's information asymmetry. We also know that there are structural limitations for positioning. We know a lot of these things can lead to overreaction to information as well. That's how we get things that go up massively and then have these nasty reversals. Why would something go up 30% and then 2 days later be down 60% or 40%? The market just said it's worth this.

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