When options spread trader Bill Stevens competes in fly-fishing tournaments, he leaves nothing to chance — not even the fly lures.
“I tie my own,” he says. “And I tell you, when you tie your own flies and then you go and catch a fish on ’em, it’s the best feeling in the world.”
It’s a passion he discovered between marriages — and fortunately for his trading, he married a mathematician the second time around.
“I’m much more interested in the relationship of the options to the futures or the options to each other or one skew to another skew, than I am absolute values,” he says. “That’s where we try to make the money, and we try to do it on a very consistent basis.”
The consistency is what attracted Strategic Ag Trading (SAT), a commodity trading advisory group headed up by former Chicago floor trader Bob Wiedeman (see “Hot new CTAs,” October 2004). Wiedeman and his stable of traders have built up a respectable track record as admirable for its low drawdowns as for its above-average returns.
Stevens joined the team last year, and all three men share a respect for the inevitability of random events and rarely commit more than 4% of their equity to margin.
“We may not hit the grand slams, but we’re not here for grand slams,” says Wiedeman. “And if we do hit them, it’s only because the market gave them to us.”
A cornerstone of Stevens’ approach is the premise that options are all about the discovery of volatility, just as futures are about the discovery of price. However, the foundation is a solid understanding of the grain markets from the bottom up.
The son of an Elgin, Illinois farmer, Stevens started trading cash grains for Peavey Grain in Minneapolis right after graduating from the University of Illinois with a degree in economics in 1973.
“We learned to do everything back then,” he recalls.
“We learned to load the grain, to do the accounting, to trade barges and rail — A to Z.”
He began setting up hedges for customers and his trading shifted from cash to futures, then gradually from hedging to speculation. “My approach was always to try and impact the bottom line rather than just to provide a straight hedge,” he says.
In 1983, he bought a seat on the Chicago Board of Trade and began trading soybeans for himself, almost always in spread positions, usually either basis (cash vs. futures) or the “crush” (soybeans vs. soybean meal and soybean oil).
“These were the days before Continental Grain left the pits,” he says. “You still had Louis Dreyfus and Central Soya and ADM, the laundry list of big ag players doing all their business on the floor.” The volume ensured a tradable convergence between cash and futures prices oward expiration, but the conglomerates soon realized they could keep the basis trade for themselves by taking the supply chain in-house.
“The spreads became spec-ulative, and you had to find other things to do,” he says. “That got me interested in options —quickly.”
He traded option spreads on the floor for more than a decade, and as the markets have gone electronic, so has he. By 1999, he was cutting back on the floor-trading and fiddling more and more with computerized models.
“I love to trade gamma,” he says. Although Delta measures the amount an option price will change per the price of the underlying, gamma measures the change in an option’s delta relative to the change in the price of the underlying.
For Stevens, gamma represents an opportunity to distill volatility into its pure form, and to make money when the volatility reflected in options gets out of sync with the actual volatility of the underlying commodity. He’s constructed a band-based indicator based on a 50-step binomial pricing model. The center represents equilibrium, while the bands represent either high volatility or low volatility.
He selects core positions based not on how many indicators reinforce each other, but on whether the direction his indicators point to suit his trading style. Ideally, that means finding a situation where he can take a long gamma position. “We’re trying to verify something else that we see in volatility, to increase the probabilities,” he says. “My preference is to adjust in the direction of the market, but if you’re short gamma, you’re adjusting against the market.”
Now, as for how he ties those flies…