Dan Passarelli is the author of the books Trading Option Greeks and The Market Taker’s Edge and is the founder of Market Taker Mentoring, LLC, which provides options education for traders. In 2005, he joined the Chicago Board Options Exchange (CBOE) Options Institute and began teaching both basic and advanced trading concepts to retail traders, brokers, institutional traders, financial planners and advisors, money managers, and market makers. He has also given webinars for the International Securities Exchange and appeared on The Options Insider’s radio show.
Q. A little bit of background: Your web site proclaims that you are a “Market maker turned market taker.” What led to your switching from one to the other?
A: I believe the edge is no longer on the trading floor. When I started as a market maker, the edge was decidedly in the hands of the market makers. The bid ask spreads were 25 cents wide in some series — specifically, a quarter of a dollar wide, because we were trading in fractions. I slowly watched all the changes in the industry, like the decimalization of stocks and then options, and then penny pricing, and payment for order flow. A lot of the market makers who at one time were purists profiting from the bid-ask spread, then became position traders themselves. I didn’t want to pay $10,000 per month for an exchange seat in order to be a position trader. So I decided to leave the trading floor and at the same time I started teaching classes at the CBOE Options Institute.
Q: You enjoyed that?
A: Yes, and actually I didn’t think I would. Market makers can be rather brash. At first I figured “Those who can, do, and those who can’t, teach.” I, in some ways, almost reluctantly joined with the CBOE options institute and then found that I loved it.
Q: Market Taker Mentoring, LLC, which you founded about three years ago, offers many different kinds of options education including a free options training video, live online seminars, personalized options coaching, an options newsletter, plus the Market Taker Minute, where you answer viewer’s/readers questions about options strategies. What did you start out with when you founded MTM?
A: The first thing I offered was the one-on-one coaching, which I still do.
Q: Where do your students come from?
A: From London, Wales, Switzerland….it’s all done online, and it is truly global.
Q: Are they mostly retail traders?
A: I prefer to use the term “stay-at-home traders.”
Q: You also put out a newsletter called “The Market Taker Edge,” for which you offer a two-week free trial. What types of content are in the newsletter?
A: It is probably the most unusual subscription newsletter you will come across, because my objectives are the complete opposite of everyone else’s. I give the news from the past week and [predictions for] the coming week, an educational piece, and three actionable option trade ideas. That part is not unusual. What’s different is the intention and execution of my trading ideas. Most newsletters want you to be reliant upon them, to keep coming back for the hot picks. I give the trade ideas every week, but I explain how my thought process works. I explain why I selected these trades. I try to impart how the mind of a trader works and what you need to think about to succeed at trading. The day someone signs up for my newsletter, I am effectively trying to wean them off of it.
Q: You mention on your web site the importance of hedging “the right way,” and you say married puts and protective puts don’t work. Can you briefly say why they don’t or why there is a misconception out there about them?
A: They don’t work because of how people trade them. They are designed to work, and conceptually they ought to work, but they are very expensive ways to protect yourself. And the way people teach it and consequently the way people learn it is that you buy the puts and hold them until expiration. But if you do that the put becomes oppressively expensive.
Q: You spent many years on the CBOE and CBOT floors. Can you talk about one mistake you made early on and what you learned from it?
A: One important thing I learned was to take off trades when the risk/reward is no longer there. As an example of that, I traded a company called Network Associates at one time. I happened to be short a lot of far out-of-the-money puts. It was something I’d done a hundred times before, and I just thought I’d let them expire because they were so far out of the money there was no point in buying them back. However, on the particular day a news story came out that the CFO of the company was cooking the books or something, and the stock lost about 50% of its value. I lost $200,000 that day, when the most I could have made was a few hundred dollars. It was an expensive lesson but one that I now teach my students.
That is clearly the most common mistake I see retail traders make.
Q: Do you still trade? Are you involved with trading volatility products at all?
A: Yes, I still trade. I do from time to time trade volatility products. I just wrote an article for TheStreet.com on it. It appeared in their Options Profit section. *
Q: In addition to market structure, trading technology has changed quite a bit since you traded on the CBOE floor. How did you yourself learn to adapt to the changes?
A: Kicking and screaming mostly. It was a big change. I saw the whole thing from start to finish. Each change that came around just made it harder on market makers and easier on the general public.
Q: There has been a lot of discussion about what’s happening to market makers lately. What do you see happening in the future? Is it conceivable that market makers might go away?
A: The market maker function is certainly not going away; it’s just getting more efficient out of necessity. It used to be one guy standing in open outcry making markets in five or ten stocks. Now it’s one guy with a big computer who programs it to make markets in hundreds of stocks. There is a lot more inter-class spreading going around, trading the volatility of one stock or index vs. another one. That makes the markets as a whole more efficient as far as volatility pricing goes.
Q: What is your most recent project?
A: My second book, The Market Taker’s Edge, just came out. It actually revolves around a lot of what we’ve just talked about. It is written from a floor traders’ perspective, with the objective of helping the market taker, because every trade that you or I make we’re probably trading with a market maker. I’ve got a chapter titled “Know Your Enemy.” If you want to be able to trade against these guys, you have to understand them. I’m helping individuals understand the options market as a whole and the nuts & bolts of options, so they can use that to their advantage.