Five Minutes with Randy Frederick

Sep 15, 2010

Randy Frederick, Director of Trading and Derivatives at Charles Schwab & Co., is the company’s options guru. He sat down with MarketsWiki’s Jessica Titlebaum to discuss his ascent into the options space, the difference between equity and options traders and why he is so passionate about this industry.

Q. Did you have any mentors throughout your career?

Greg Miller was someone I aspired to be like. He worked at Schwab when I was a broker and a manager in Indianapolis. He was the Options Guru, the guy that came around and taught everyone about options, and I was one of those people. I was very lucky to have developed a strong relationship with Greg about a year before he left the firm in 2004. As a result of that friendship, when he moved on, I was very fortunate to fill a lot of the gaps that he left. I happened to be in the right place at the right time. When you look up to someone and aspire to be them, you often don’t expect that to happen and I was fortunate to have stepped into his shoes.

Q. What did he teach you that you remember?

You have to love this business. You have to be passionate about it and that’s the most important thing of all. The people that I have met over the years are either very passionate about it or scared to death. If you are scared to death, I don’t think you ever get out of it. If this is going to be your career, you have to be focused and passionate and love what you do.

Q. As a Schwab spokesperson, what are the most frequently asked questions?

I do a lot of analysis on the derivatives markets, primarily the options markets. Most questions revolve around the VIX, put-call ratios, volume, and open interest. Investors are trying to gain perspective on where the markets are heading, either from a fundamental or technical perspective.

I have been involved in options trading for over 20 years and I believe that options traders have more of a tendency to make a commitment in one direction or the other, a little bit sooner than equity traders. Despite the fact that the options markets are a derivative of the equity markets, I believe they often show you what is going to happen in the markets a little bit sooner than equities.

Q. Why do you think options traders can commit quicker?

Many options traders have more experience and knowledge of what is going on in the options world and in the economic world. They are willing to make more of a commitment and believe they are right more often.

Equity investors are much more passive, especially if they invest in mutual funds, which are the most passive way to invest. Mutual fund investors, by nature, tend to chase performance. They are intentionally in mutual funds because the decisions about which investments to buy are made by a portfolio manager; an experienced professional. The mutual fund investors tend to be less savvy than active traders.

Active equity traders tend to be more market savvy. Once they become fairly successful and achieve good results as an equity investor, they look for the next thing, which is often the options markets. They are looking for ways to protect equity investments by using hedging strategies or improve their equity results by using income-generating strategies: things that will help their equities do well in all markets. If you are strictly an equity investor you really only have the ability to profit in an up market unless you want to be a short seller. There are a few short sellers; not many. You can also profit in a down market but you can’t profit in a sideways market.

If you are an options trader, you can be profitable in up markets, down markets, and sideways markets. It’s like a natural progression for equity traders to move into the options markets.

Q. How did you get into the options space and this industry?

I fell into this industry by accident. I graduated from Indiana University in 1988 with a degree in Marketing but the economy was rough back then. After being out of school for three months, believe it or not, I found a job through an ad in the newspaper. It was a customer service position with a local broker/dealer in downtown Indianapolis. They immediately put me in a classroom half the day and in the office the other half of the day. The class work was to teach me the content to pass my Series 7.

Once I started to learn about the business, the idea of becoming a stockbroker was very fascinating to me. I got my license and stayed there for about 5 years before moving to Schwab.

I got interested in options the same year I got my Series 7 license, which was mid 1988. By the end of the year, I had done some trades in equities, mutual funds and someone had shown me an options trade and I was fascinated by it. That fascination never left and now I have been in the industry for 22 years.

Q. What is it about the industry or options that fascinate you?

If you are an equity investor, you can buy [a stock], and if it goes up you make money. You can sell it short and if it goes down, you make money. That’s pretty much it. With options, there are infinite possibilities. Income strategies, hedging strategies, strategies to help improve your equity positions, to hedge your positions, there are calls and puts and spreads and straddles. Then you start getting into volatility and understanding the Greeks and how options are priced; the possibilities, the details, the complexities are just endless. The more I learned, the more I was humbled because the more I saw how much more there was too learn. Even now that this is my full time position and it has been for many years, there is still so much more I can learn.

Q. Where do you see this space going? What’s next?

Compared to the equity industry, the options industry is still pretty young. In its current form it has existed only since the early 1970s — so only forty years. The equity business has been here for over two hundred years, so options are still relatively young.

The growth in the options industry was tremendous from 2003- 2008. There was double-digit growth. 2009 was the first year that growth was just under 1 percent, but we are potentially on track again for another 10 percent year. There are not a lot of limits to how this industry can grow. The number of investors coming into the options industry is growing like crazy and it doesn’t seem to be anywhere near it’s peak.

If you look at the total number of people in the investing public and what percentage of them actually trade options, it’s a very small percentage. That is encouraging when you consider the enormous opportunity we have to educate the average investor on the benefits of trading options — and not for speculating, but for income generation and hedging.

Q. Why did growth catapult in 2003?

What catapulted growth in 2003 is similar to what we have seen recently. The Internet bubble started in about 1995 and peaked in 2000, and then there was this big decline. I think what happened was that a lot of people thought equity investing was easy. People were quitting their jobs to invest in Internet stocks and they were making money hand over foot, and then they got wiped out.

Most people got out of it and never wanted to get back in. Others wanted back in but in a way that was a lot less risky. So there was this big demand for options education and options trading. Then we went through a nice period of growth from 2003 to early 2008. Once again we had the same problem, the financial decline came through in 2008. In 2009, a lot of people got clobbered and they are waking up to the same stuff they woke up to last time saying there has got to be a better way of doing this. Investors shouldn’t be going through these boom and bust cycles where they lose a chunk of their portfolio.

Our active investors tell me regularly that they don’t want to get out of the market when things get rocky. They want to be invested in the market all the time but they want to do it in a way that will reduce their risk and ensure that they don’t get clobbered when the pullbacks occur. One of the best ways to do this is to use options to hedge those positions, and people are waking up to that. This is partly due to the efforts of the OIC [Options Industry Council], the CBOE’s Options Institute, and ISE as well as Schwab and all our competitors. We all have robust educational information and it’s easily obtainable over the Internet.

Q. You travel a lot for business. Where are some of the places you go?

I go to all the big cities in the country. The most frequent are New York, Vegas, Chicago, San Francisco, and places like that. In the next few weeks I will be in Sacramento, Orange County, Chicago and Boston. Wherever there is a large city, a lot of investors and a demand for educational and live events.

Q. What city do you see has the most options traders? Any that would surprise us?
I think Chicago has the most because CBOE is there and it was the first options exchange. Second would be New York, but then I would say Fort Lauderdale, where a lot of New Yorkers vacation and have second homes. Also there are a lot of affluent and savvy people in Orange County.

Q. What was the hardest business decision you ever had to make and what did you learn from it?

It was in 2006 when I was asked to take on an additional role at Schwab. I was responsible for managing the contracts and the relationships with all the quote and data providers. I was trying to do that in addition to everything I already do with the options markets and it became overwhelming. I was working 12 or 13 hours a day and on the weekends. I did this for almost a year. It was more than I could do.

The tough decision came at the end of the year when I was offered a position, which involved a promotion and more money but I had to completely leave the options business. I went home and thought about it and what I realized was that I love the options business. At that time, I had been in this space for 18 years.

I thought, if I make more money and have a better title but hate getting up and going to work because I’m working on something I am not passionate about, it doesn’t matter how much they pay me. I would rather make less and like what I do and come to work and be passionate about my job. It was a very hard decision, but looking back I don’t have any regrets. I think you need to love what you do first and the amount of money you make doing it is secondary.

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