Tom Sosnoff | Ten Trades You Need to Know in Order to Make It in the Business of Finance

all right awesome how are you guys how many from Stacey of New York at Albany AHA we're you um which hey which one Indian River where is Indian River I did an interview last year we're gonna do one again where else Indian River world you see up you see up is the only traveling finance club in the world just so you know somehow I'm walking down a hall in Las Vegas casino couple 20 you speed up finance Club members it's awful scary so we got UCF Indian River where else it's alright so anyway I think

this is an incredible event because we get I worked my butt off to get a lot of people in a room just to hear about finance and and truthfully our demographic is about you know the average demographic of the day which is at least you know hundred thousand people a day is a 55 year old white male that's essentially our demographic so when I see this room I'm like wow this is so cool because you know you guys are you know the next generation I mean the torch and Finance and Finance is really cool but

it doesn't have a great reputation so I decided to do something a little different today and I hope you like it it's a pretty fast paced presentation I'm going to show you ten strategies or ten trades I don't know I don't not sure best how best to classroom ten things you need to know and I assume everybody that's from I assume we have everything from freshman to graduate students so my purpose in this ten slides three to four minutes per slide talking about a specific area of knowledge that will help you get to the next

level in finance you know when when we interview people and when we talk to people inside the industry we look at how how strong are you at articulating finance how strong are you word articulating math how strong are you at explaining strategies how strong is the depth of your understanding and let me tell you something you have an opportunity every one of you to change what has long been a legacy of lack of know-how and lack of expertise and mostly just about asset gathering you have an opportunity to change an entire industry and make it

about strategy and make it about logic and make it all kind of make sense to people because you'll be able to explain it so what's so neat about this discussion is I'm going to go through I think the ten things that I want you to know if you are coming to our firm as a you know as a let's say somebody that just graduated either undergrad or grad school and was looking for a position and you were interested in one of our research position one of our deb positions one of our trade trade desk positions

or whatever else it was the things that i want to hear from somebody is an understanding of the following 10 pieces so I'll take you through this and we'll do it quickly 10 things to know to succeed in finance ready let's do it so first and I'm going to take it again the foundation of all derivative strategies is understanding options why because options are a great area they're a great area product which means they're strategic in nature you can be wrong using option strategies and still make money and you can be right using option strategy

and lose money to me anything that is not black and white anything that is gray is fascinating and without a clear understanding of derivative strategies which is not taught in very many places through academia other than very basic textbook stuff it's important to know the number one concern we have when interviewing somebody is a lot is that they really have a depth of understanding I don't care if you can recite black Scholes or you could explain the math model behind the Greeks what I care about is that you understand specific derivative strategies that focus on

the application of a strategic mathematical quantitative approach to investing so the single most important piece is and I know this sounds kind of like well enough capital trade options I don't have enough I don't really have enough opportunity to do different things in the derivative space whether it's listed options whether it's over-the-counter options whether it's commodity options or whatever else it is an understanding of basic option strategies which means buying stuff spreading stuff and selling stuff is critical to next level success so the second piece number two is understanding the futures markets because remember markets

go to liquidity and markets go to leverage and the single most liquid leveraged marketplace is the future place so understanding that futures and futures options have a are highly correlated to individual equities and they also have this characteristic we call product indifference which means 1sp future is the same as 500 shares of spiders which is the same as 10 at the money options or 5 in the money options understanding that they're all the same product gets you immediately when you're having a discussion with somebody talking about finance your I'm product and different I couldn't care

less which product we use we'll use the product that's most liquid that gives us the most choices strategically that best fits what we call efficient use of capital efficient use of capital is why would I buy 500 shares of spiders and put up $70,000 $70,000 when I couldn't buy one SP future and put up fifty five hundred dollars and they're the exact same position or buy ten options and put up 2500 hours and they're all the exact same position there's theoretically equivalent so understanding the relationship and having this real acceptance of product and difference when

it comes to finance put you in a completely different level when you talk to a finance professor when you talk to an interviewer when you talk to somebody that that you if you want to go to the next level whether it's banking whether it's financial services or whether it's in the professional side of the business it could be a hedge fund a prop berm or whatever else once you get into business you have to be able to articulate the difference between products and how it doesn't matter to you because very few professionals can really explain

that so this piece is untanned the relationship between different products and the pair's relationship which means understand have a clear picture of what dis correlation meet and how does beta work and in today's technology just log on to any platform and you can essentially see what your beta waiting is to the S&P 500 which just means how correlated are you to the S&P 500 and if you have two different underlines on like for example most industry professionals think if you're if you're long emerging markets and you're long US stocks you are diversified but the reality

is if you're long US stocks and you're long emerging markets and they have a correlation of let's say 75 you're not that you're not that diversified but if you're long US stocks and your long gold which has a correlation of basically zero then all of a sudden you're diversified so understanding and being able to explain what correlation is and what and what divergent what essentially what divergent markets mean and where that opportunity is what's a pairs trade a pairs trade is buying something and selling something else that is highly correlated but that correlation has gone

out to price extreme so for example recently on the last rep run up in the stock market the S&P um the SPS of the Nasdaq and the Dow exploded up here and the Russell didn't move at all so that relationship between the russell 2000 and the and the Dow list so say for example exploded up to the widest that's ever been recently that's come back down and that's a nice correlated pair that got to a price extreme got way out of whack and just came back into line the same thing you can you can use

the same thing for you know gold and silver you can use the same thing for 10-year ten-year notes in 30-year bonds but understanding how beta works and I'm assuming that most people understand beta and correlation because they're very close to each other and understanding divergence between correlated products that's where opportunity is you know opportunity is not saying hey if you came in as a lot of really understand the markets that I'm really excited about gold because I think it's going higher we couldn't care less if you came in and said you know what I've been

studying I've been studying IBM really convinced the stuff is on this stock is on a low and I love this company we couldn't care less but if you said to me that the correlation between IBM and Microsoft is 73 and that the divergence between prices the widest level it's been at in 25 years all of a sudden I'm interested if you said to me that that I watch bonds and I watch notes which is essentially the yield curve and that's flatten to a level that we haven't seen in you know 45 years all of a

sudden I'm interested but if you told me you're bullish and bonds or bearish on notes couldn't care less hopefully that makes sense because I care about your ability to your ability to articulate divergence and opportunity I don't care about what you think about the markets nothing less so that's neat next thing is a specific opportunity like the yield curve which I just mentioned so not too many 20 year olds or 21 year olds get an opportunity to understand and trade something like the yield curve but if you knew you could trade it for maybe a

few hundred dollars or even less than that maybe it's interesting the yield curve is the relationship between long term rates and short term rates and recently that relationship got down to a level that we have never seen before meaning that yield curve had narrowed and had flattened to a level where it was trading let's just say if I could throw a number on it about 35 basis points well if you believe it will go Burdett which is fair to assume then there's 35 basis points of risk to the downside and the norm for that relationship

is about 125 basis points so if you could articulate that hey and this is what I want to hear from young people and I hear it sometimes and when we hear it we get all excited because we're like oh my god this is a different level of understanding but if you can articulate that hey something's trading at 35 basis points it's got a floor at around zero and it averages 125 well the first thing that goes through my head is those are amazing pot odds and pot odds a cinch essentially what we're playing for because

we don't know what's gonna happen so what are pot odds pot odds are when you have 35 ticks and risk and 70 ticks and potential profit just because it's a math equation not because you think it's going to happen and that's the fascinating thing and again what I'm trying to prep you for and I only have 45 minutes for this is being able to articulate like why you would do something what I love is when somebody can explain to me I'm doing this because I believe it's a 50/50 shot but I can make two and

a half and lose one that's all you need to hear because then you saying wow this I like the way this person's thinking I like the way they're working through you know the pot odds or the math on this the yield curves interesting because everybody understands interest rates and bonds are you know whatever a 30 40 trillion dollar space in the listed marketplace you can create them down to derivative you can use derivatives all the way up to you can use options you can use ETF so you can use futures and you can trade them

for with very small amounts of money and one of the best things to learn especially if you just have a you know a small amount of money and you're starting to learn how to trade one of the best things to trade that has the lowest implied volatility has Laur implied volatility relative to stocks but it still moves around a lot is the yield curve so it's just a suggestion if you're looking for something to try we have a yield curve that's very flat over the last years and years and years of easing and it's something

you might want to consider but at the very least you should be able to explain it because once you can explain the opportunities in interest rates you can easily explain the opportunities in bonds and other commodities and it all just kind of snowballs from there so which takes me to a little bit more of a complex topic but you need to understand valar and valve dispersion are what same thing but you need to understand the relationship between volatility which is expected move and Finance because essentially I'm sure you've read this past week that and I

talked a little about this last night if you came to my snipe but over the last week you've seen a bunch of inverse volatility funds kind of blow up but that takes that kind of puts a that kind of puts volatility in a bad light but volatility is very simply just expected move and if you can't explain an expected move and you can find opportunities inside a volatility because volatility is essentially a measure of opportunity just a fear gauge and one of the neatest things for finance students anywhere is being able to explain Val ARP

because every professional loves the concept of var because it makes sense XYZ is trading with a 30% volatility ABC is trading with the 20% volatility they have a correlation of 80 so I'll sell the 30 buy the 20 and then I'm highly correlated so if the markets move in natural random fashion there should be an opportunity to make money in there when volatility normalized because remember volatilities mean reverting so the neat thing about barb is if you have a mean reverting asset and it's stretched to a point of some kind of divergence then all of

a sudden you look at you go wow this is a real synch story I don't know if it's gonna work but it's an interesting story I can sell this buy this they are highly correlated and maybe if they go back to their means we profit from that now again what's neat about this is you have to be able to explain it and once you can explain it you're at a different level in finance almost every quant fund almost every prop firm almost every hedge fund deal specifically with bow arm and as soon as you understand

essentially eventually as an individual investor I trade volatility that's all I do and most people that are individual investors that are successful essentially trade volatility as as self-directed investors but it requires just a little bit of capital and when you're learning just understanding the basic principles behind Val are very important in explaining kind of you know why you're excited about this industry the next thing is hedging and hedging is something that we don't necessarily cover in a classic fashion so hedging is something like let's say you want to stock XYZ it's trading for a hundred

and you want to hedge it my question would be why like why would somebody head your stock because you're worried about it going down right if you're along it and if you're worried about it going up if you're shorted so that's probably why it would head your stock but then why wouldn't you just sell it and so the argument for hit individual stocks to me is pretty weak because if you own a stock and you think it's going down just sell it and forget about the tax consequences for now and if you're short of stock

you think it's going up then just cover it because heck ting it is too pensive what is you expensive because the implied volatility numbers or the expected move is greater than the realized move so when you hedge something you pay a number it's essentially insurance and you pay a number that's statistically beneficial to the seller not to you so then why do you have to learn about hedging you have to learn about hedging because it's not about being individual thoughts the key to hedging if somebody asks you the question or when you go to talk

about hedging in an interview or you go to talk about it when you're writing a research paper or you're doing it for a school project the neat thing about hedging is understanding that hey I have six different positions on or you have 30 different positions on or this fund has a hundred different positions on ER this Bank has a thousand different positions on how do you hedge that portfolio how do you neutralize that portfolio using using the concepts of product and difference to get you to a point where you can say hey we're going home

flat tonight or we're going home without that much risk on very few people understand risk and very few young people understand market risks because everything - has always been black and white there's very few opportunities to make hedging decisions in your life but when you think about it and you can articulate and explain hedging all of a sudden it gets really interesting so you buy five different underlyings there's virtually there's some correlation either positive or negative between all five or ten different underlying since you buy and with one simple trade you can offset all that

risk for example your net Delta your net directional risk comes out to two or three hundred shares of spiders when it's all beta weighted to a specific underlying and the next thing you know you sell 300 shares of spiders in your flat that's called kind of that's theoretical Delta neutrality but the neat thing about this is you're all smart wouldn't be here on a you know Friday afternoon if this wasn't something you're really into and you weren't passionate about it so the neat thing is understanding hedging outside of hey I'm selling this against a specific

stock I'm buying a put against this specific stock or index or I'm selling you know this option against a specific stock or index that's not hedging you can sell those out you can close out those positions you can do whatever being able to explain that the cost of expected move verse realized move is too great to make hedging and efficient process on individual underlyings but if you want to hedge an entire portfolio that makes sense so imagine this imagine I took five different stocks in each of those five different stocks I used some kind of

option strategy or a future strategy or valve dispersion strategy some of those first three things I talked about and then when that was all said or done when that was all those positions were put on at that point the next thing I said is make me flat so the game plan is collect all the premium from the volatility reverting to the mean because that's a math model and then hedge position theoretically by using a static underlying like stock or futures once you can explain that you can work for anybody and I know you're looking at

me like I think he may be crazy and it's possible they may be but we have we have put so many young people in positions of managing huge amounts of money and really taking out a lot of responsibility throughout the world of Finance just because they can explain these ten topics that I'm showing you today that nobody else ever talks about in a different way and I know you're listening to saying I'm not so sure that's true but it is it is you know we've seen people go from like just first time interviews to basically

being portfolio managers because they understand that there's way more to this business then then they've ever kind of imagined with respect to hedging with respect to product understanding with respect to a strategic understanding oh let's talk about the importance of fear and how opportunity is priced because volatility which you see floating right now we in two short weeks we have blown up the entire short volatility bubble I'm not sure how closely you have an opportunity to watch all this but I'm assuming most of you have been aware for the last 15 or 16 months market

has traded in the lowest volatility at the lowest volatility levels both on an average mode and mean that it has in the entire history of the stock market so we got down to levels over the last 15 months that we have never seen in the history of the stock market which meant complacency was at record highs which meant more importantly that opportunity non-directional opportunity was at record lows non-directional opportunity means that unless you were bullish unless you played the market to the upside opportunity was at record lows because there's no fear in the market all

of a sudden in two weeks you've seen volatility go a little bit greater than double in some cases triple in the broad market that's an extraordinary move but it probably broke the volatility bubble that we've seen the short volatility bubble that we've seen for the last couple of years the good part and the this is number one breaking of the volatility bubble means there's going to be huge opportunity and you guys are your timings perfect you happen to be born the right you here number two is because of that up because you're gonna see extended

opportunity of the next couple of years now because since volatility is mean reverting it means that for the next few years maybe even the next decade you're going to see increased movement in all markets when you see increased movement in all markets you see an increase in trading activity when you see an increase in trading activity you see an increase in job opportunities and all of a sudden the employment space in the financial side when markets get volatile explodes I know that's kind of a backward down trickle down approach to it but when the business

is running and flat and there's nothing happening and there's no opportunity there's very few jobs as soon as opportunity starts to happen as soon as volatility starts to explode all of a sudden everybody gets more because all of a sudden we realized that you know bull markets make people into geniuses that aren't geniuses and bear markets and explosions in volatility not saying bear market I'm just where we've seen an explosion of volatility recently an explosion and volatility gives people that are smart logical that can use common sense an opportunity to shine so the takeaway from

this is if you you recognize what's going on right now you'll see that there's a ton more opportunity and there'll be a ton more opportunity going forward than we've had for the last five years so if you're about to get out of school or whatever you know where this is something you plan to prove the opportunities ahead of you now will probably be pretty good for the next decade and your ability to explain all this stuff will be very supportive as to your foundation you know of so digital strategies because I promised I'd touch on

this so let's talk digital for just a second so digital is your world I know they say I mean it's my world too because I trade digital but digital essentially is your world it's a millennial world at least at this point when did various you know firms all over the world the problem with digital strategies are is there are none the wonderful world of digital currencies Bitcoin and everything else included is there's no depth of the market there's no listed liquidity that's worth anything and there's no strategies so as much as I love the digit

I'm much as I love the space because I think it has the potential and I say potential because it's interesting but it's all potential still because right now it's a speculative asset bubble and whether it becomes something later on we don't know but the reason I think it's important again because it's a piece of your ability to articulate the space the problem in the digital marketplace right now which includes 20 200 different currencies which includes you know the ico market which includes everything else is that it's very black and white either you buy them and

you hope it goes up or you sell them short which is really hard to do and you hope it goes down there's a lack of liquidity there's a lack of of there's a lack of a listed marketplace trading and there's a lack of transparency among the firm's making markets that always becomes hard to scale but eventually they'll take you know they'll hit the let the listed marketplace what you need to understand in the digital world is what it is how it works and where the opportunity is so if some 21 year old comes in where

22 year old comes in and says to me hey you know what I'm a digital currency expert my first question would be what does that mean you're a digital currency expert because I'm a digital currency expert I would say because I think X Y Z is going higher does that make me an expert and they'll be like no no no no here's why I'm an expert and I want to hear and if you can say to me I'm an expert because I am preparing myself for when there are derivative strategies available or for different arbitrage

opportunities between markets or because you can explain the correlation between different products and you can explain the divergences between different correlations and you could a figure out by backing in looking at the numbers what the implied volatility is of these currencies then all of a sudden interested but if you tell me you're an expert because you understand how they work and you understand and you're bullish or bearish for whatever fundamental reasons you have I couldn't care less so to me the digital space is fascinating it's wide open but for reasons that most people I've never

heard him explain there is no trade there's just Byam Hold'em hope it goes higher or sell them and hope it goes lower but it's really hard to the marketplace so for me the digital marketplace is really interesting but I need to see more I need to see a derivative space to it I need to see an opportunity where there's some transparency in the marketplace I need to see much bigger money going after it so that it becomes real anyway it's important to be able to at least talk about that so lastly getting into selling premium

so this is really important to me and we'll go back to digital for just one second and I talked briefly about this last night so sorry for repeating it in the premium marketplace premium is determined by implied volatility implied volatility in the digital marketplace Bitcoin and others averaged about a hundred and thirty percent for most of 2017 it's currently a little bit lower right now about let's call it a hundred percent but the stock market volatility is about thirty five percent or thirty three percent and when you take thirty three percent stock market volatility and

you compare the liquidity and the depth of product there's no reason to trade digital when stock market volatility is 10 and digital volatility is 130 there's every reason in the world to trade digital currencies because you can make money doing it when digital currency implied volatility goes down and stock market volatility goes up nobody trades digital and that's what's happening right now but understanding the concept of selling premium is the single most important thing that you that you really have to under the most important thing to know and to be able to talk about because

selling premium is a way of reducing basis or improving basis the only premium is way to let the market work for you if implied volatility is expected move and realized is lower than implied volatility which realizes what actually happened then why wouldn't you sell something that's higher than what's actually going to happen and the answer is you have to in order to be successful you have to so then why doesn't everybody because there's an element of undefined risk there's an element of understanding where that risk actually lies so what's so fascinating about this is most

people do not get to experience sell any premium that means like you know option premium more than anything else most people don't get to experience selling any premium unless they do something for themselves unless they trade their own account unless they open up an account and make a few trades sell a credit spread sell sell sell a naked put so I'll make a call whatever it is sell a put spread sell a call spreads iron Condor cell I mean I don't care what you do still anything to see you get to see how premium decay

works especially when opportunities at a peak like it is now and all of a sudden you're like oh now I get this let's let the marketplace work for us and that's something that's kind of hard to conceptualize and even harder to explain until you've done it but really easy to do on your own because anybody can do it with almost any underlying oops okay so I just want to make sure I didn't go over here for a quick second just twenty-five perfect so those ten underlines I mean I'm sorry those ten approaches let me go

back real quickly and just go through them cuz I went through them really fast I just want to talk oh there you go that's nine there there it is right here is that ten perfect sorry about that I knew there was one more I was looking for it base this reduction I'm Victor let me finish with that so basis reduction means if you're gonna buy a stock at a 100 dollars why not buy it less than that why not try to buy it for $97 and improve your statistical chance to success if you're gonna buy

this bottle of water for $1 why not buy it for 90 cents if you can and give away your upside basis reduction means or basis improvement I shouldn't say reduction I should say improvement basis improvement essentially is the core strategy for every single thing we do being able to explain basis improvement means that you understand the concept of portfolio management and you understand the concepts behind wealth creation if this bottle of water costs a dollar and you can buy it for 90 cents you have a statistical advantage over everybody that bought it for a dollar

it can still go to zero theoretically so if it goes from $1 to zero you lose 90 cents everybody else that bought at $1 loses a dollar so you did a little bit better ten percent better but in most cases markets are random and if you can continually lower your base by giving away some of your upside you will outperform all of your competitors and you will impress those who you work with or for or for yourself and that's how you build wealth all wealth is created wealth is not created through being right wealth is

created through being smart and to be smart you need to reduce basis or improve basis to improve basis means if I bought this in a dollar I have unlimited upside but the reality of it is the expected move on this let's say the implied volatility is 30 cents that means the expect are 30 that means the expected move on this is from 70 to a hunt to a dollar 30 let me out start over this bottle costs $1 the implied volatility which is how much it's gonna move is 30 that means the expected move over

the course of the next year is 70 cents to a dollar 30 if I want to buy this at 90 I'm going to have to limit my upside to a dollar 15 even though the expected move is all the way up to 130 but if I'm gonna want to buy this at 90 I'm gonna limit my upside to a dollar 15 by doing that I buy this at 90 you buy this somebody else that doesn't limit their upside buys this at $1 statistically although my upside is limited statistically my probability of success goes from 50/50

all the way up to about 65% that's the probability of making at least one penny based on the based on the expected move so the next thing you know I have a 65% probability of success you have a 50% you have unlimited upside and I gave up on limited upside in return for side but a higher probability of success in business and Christy will talk about this next because that's what our discussions about but in business any kind of business whether you're an entrepreneur whether you're trader whether you're a money matter whatever part of the

financial space you get into you can explain that a reduction and basis or an improvement in basis improves your probability of success six breeds success what we're looking for is scalable success how can you have scalable success in random markets if this is a random market and you don't know to be 70 cents or a dollar thirty in a year it is very hard to predictable scalable success if you want to apply any one of those ten things that we talked about in finance and apply them continually you need to have scalable repeatable all of

a sudden that makes you super valuable and just being able to explain basis and pursue long-term success for any business any business that's my last slide so so I hope you had a chance I'll go through them really quick let me see if I four it's on this I don't know if I can Oh perfect I'll go through them just in for one sec so just as a really quick recap because these are the ten things I think you need to know to be successful in the world of finance and this means through the interview

process through the last year I talked about differentiation through the differentiation process through the articulation process and through just your personal success it doesn't matter to me if you're in this room and you're listening discussion finance but you're gonna enter the business world somehow you're gonna support yourself and somehow you're gonna take whatever you've learnt the first twenty two years of your life and take that into you know the next forty or fifty years of your life starts with a foundation how derivative strategies work is the one place you can go to make tons of

decisions to improve your decision-making skills which ultimately the number of decisions you make has a direct relationship with how successful you are is important to understand the futures business because the futures business drives the securities business most amount of leverage most amount of liquidity pairs trading understanding the relationship how correlation works and how price diverges because there is no such thing as mean reversion with respect to price it's just it's just a it's just something that's very objective it's completely subjective I should say it's completely subjective with volatility it's mean reverting there's a math model

behind it with price it's just subjective so understanding that and looking for opportunity that way is kind of neat next is yield curve being able to articulate interest rates and the yield curve is important because when you get to a certain level everybody cares about interest rates and yet very few people can explain interest rates if I asked my kids about interest rates and they're the same age just a couple years older than you they'd have a really impossible time explaining yield curve and I've talked about it a hundred times they won't listen yield curve

is just just a young person that can explain flattening and widening of interest rates and just how that yield curve works to me very impressive Val ARB the the essence behind and kind of some of the essentials behind the entire professional world of finance and just knowing that volatility and how it works and how it is expected move and how correlation plays a role with respect to premium and volatility is a special skill and very few kids have it hedging knowing that individual stocks individual underlyings very difficult to hedge and probably not worth it because

the expected move is greater than the realized move which means you have to pay the price of the expected move which means it doesn't work or it doesn't where it's not worth it so hedging is a portfolio thing volatility understanding essentially that volatility is a measure of fear and it's a measure of expected move and as soon as you learn how to take take advantage of volatility because you understand what it really is fascinating stuff digital strategies just get what it is understand be able to understand explain blockchain be able to understand explain various currencies

just to keeps you well-rounded informed it makes you sound intelligent but remember right now there's no real marketplace there I mean I know there's lots of trading going on and I understand that lots of small trades and everything else but it's not scalable enough at this point and it's not interesting enough strategically to play a role especially with us selling premium critical to understand what that is and how it works and the logic behind it and the math behind it because it is the one way to take advantage of outsized volatility and lastly basis improvement

because basis improvement in the end is your key to long-term sustainable and repeatable success