4 Options Trading Lessons from My Dad

My dad passed away last night at the age of 87.

Thus ends perhaps the longest independent options trading career ever, as he started not much after Day 1 of publicly listed options and he literally traded until he couldn't sit at his desk any more. And that was only a couple weeks ago.

My dad was one of the original options floor traders. He started making markets on the American Stock Exchange in the mid-'70s. It's so long ago in options time, they hadn't invented put options yet. Nor had they invented the monthly expiration cycle. Everything was on a quarterly cycle.

How did you price call options with months to go with no put options to set the reverse/conversion market and no nearer-month options to help you set implied volatility? I have no idea, though I'm pretty sure the phrase "implied volatility" was somewhat Greek to him. And not the kind of "Greek" he knew, as in "delta" and "gamma." The American Stock Exchange had something like three market makers back when he started. And all products were singly listed, so thus specialists and market makers didn't have to compete with the CBOE and … well, that was about it. The PHLX and the P-Coast were around, but much much smaller and there was nothing else.

Thus, the quote was your friend. Namely, you could quote the bid/ask spread as wide as was allowed, and you didn't have to break price, in that there wasn't anyone there to "teeny" you just yet. ("Teeny's" or "steenths" were "sixteenths." Yes, stocks traded in "eighths" not that long ago, and options in "sixteenths.")

Of course, like any business, if it was good, competition came in. And before he knew it, the floor was flooded with market makers. So, he did ultimately need a strategy. And he had a clear one: Sell everything. Sell calls, sell puts, sell stock.

Seriously, that was the gist of how he rolled. But he wasn't at all reckless about it. He had his disciplines and he had terrific horse sense about the markets. And he persisted.

Anyway, I wanted to pass on a few of his tenets. The market structure has changed unbelievably in the last 40 years, but many of the basics remain the same.

Scale Orders: If he wanted to buy 1,000 shares, for example, he wouldn't just go to the market and buy 1,000. He'd bid for 300 shares around "here," 300 maybe 20 cents lower, 400 another 20 cents lower still, stuff like that. He was the ultimate in averaging up and down. He never once mentioned buying a bottom or selling a top, but I'm sure it happened many times from the mere fact that he never tried to pick "the" price. Which leads me to...

Always Keep Some Ammo: I'm sure at some points he ran out of buying/selling power, but the moves would have to be pretty extended for him to run dry. He may have taken the scaling concept a bit too far at times, but he always wanted to be in a position to make that next play. I'm pretty sure if he knew the term "mean reversion" it was from reading my posts over the years. But it was the underpinning on his basic theory on trading and he didn't even realize it. In extended moves he would often say "This too shall pass." He'd probably think that about our current ugliness.

Use a Line Count for Risk Management: I'm sure he looked at the position risk plots that have gotten way more sophisticated over the years. But his basic tool was his "line count." He would just add up his long and short calls and stock (and/or long and short puts and stock) and whatever the net short was represented his "risk." His point was all the time premiums and verticals and what-not all have limited losses, so if your call (or put) count was low, or even positive, you could afford to maintain your delta risk and wait it out.

Never Double Down, Cut in Half Instead: When a position was going against him and it was occupying all his trading thoughts, he knew he needed to do something. His take was when you get to that point, never add to the position and exposure. Rather, take half off. It may not fully solve the actual problem, but it solved the emotional problem with the position. If you sold at the bottom, well, you took your hit and it's in the rearview and now you're making some of it back with the half you still have on. If it keeps dropping in your face … well, at least the pain is less, and you can probably start playing again and, more importantly, not letting this bad position take up all your trading energy.

There's many different ways to skin the trading cat. These were a few of his.

Thanks, Dad.