“Chicago’s Mercantile Exchange is actually the biggest trading floor in the world,” Aaron said, waving a proprietary hand at the staggered platforms thronged with traders in boxy, multicolored smocks. With screens broadcasting green, red, and yellow readings for everything from the Euro to yesterday’s closing price on live cattle for February 2009, the floor is kind of like a train station with the time inconveniently left out of any arrival or departure information. There are no windows, only screens, and photos don’t do justice to the pallor that this much florescent light and grim determination cast upon a person’s face.
Aaron and I were friends in college. A musician and philosophy major, after graduation he and some friends started a performance space and record label in Chicago. A little more than a year ago, he surprised a lot of us when he announced he was going to be a trader. However, once we realized he’d still make it to the bar to hold court on the virtues of Miles Davis or Eric Dolphy, his career choice became little more than a quirk.
And then the world financial markets crashed. With phrases like “sub-prime,” “bailout,” “regulation,” and “broke” being tossed around like beanbags—albeit very important beanbags one ought to know as much about as possible—it was time to bug my trader friend and learn something essential.
At the bar over Thanksgiving, I cornered Aaron and, taking advantage of his holiday cheer and alcohol consumption, asked to see “the Merc.”
He took the request in stride, handed me a shot, and leaned back on his barstool. “I can show you around, no problem. I’ll even let you trade a one lot and keep whatever you earn.”
A vision of myself, smocked, surrounded by jowly men, throwing up hand signals and writing furiously on a notepad danced through my drunken imagination: I was gonna be rich!
Step 1: Wait for the Opening Bell
The following Monday, after touring a sea of clerks, brokers, runners, and traders who, rushing to and fro, resembled a bowl of agitated M&Ms, we made our way to an elevated platform overlooking a gently recessed ring of people who work in commodities. Each market has its own pit, where only a single commodity—in our case lean hogs—is traded. From this vantage, it was possible to see the screens at the top of the room, most of our section of the floor, and many, many bald spots.
Aaron is a trader, with two successful backers funding his investments and taking half his profits. His overhead is high: He trades digitally with computer software that costs more than $3,000 a month and requires two monitors and its own server in the basement of the Merc. He elaborates: “Options trading, especially pork, is behind the rest of the business because it’s a complicated thing to create software for. It mostly still trades in the pit, but digital trading is growing.”
The basics, as I would painstakingly learn during the course of the day, are as follows:
Options trading is different than stock trading in that you are buying or selling the option to buy or sell a commodity—cattle, corn, soy, pork, dairy, crude oil, etc.—at a certain price in the future. The right to buy is called a “call”; the right to sell is a “put.” You can sell the right to buy, and buy the right to sell, and for some reason the universe doesn’t turn itself inside out when you do. Once you’ve bought the right to buy or sell a future in the future, you don’t have to actually trade the commodity at all, but you can make or lose money as the price of that option to trade goes higher and lower.
Options trading does resemble stock market and futures trading in that, generally speaking, what you want as a trader is a strong market where the value of the things you’ve bought increases and allows you to sell at a higher price. And, like the stock market, the options market last December was, generally speaking, nervous and slow moving.
While we waited for the 9:05 opening bell, Aaron explained that on Wednesday, the day before Thanksgiving, pork closed high in all months but October. “I’ve got 11 options of October 2009 that I need to sell off because right now,” Aaron pulled out a packet of printouts and drew a line across the center of the page, “I’m a little long on October.”
“What the hell is ‘long?’” I asked.
“‘Long’ means I am holding more than I want to be holding,” he explained. “‘Short’ means I don’t have enough and I can buy more.”
Since the pigs that would be sold in February 2009 were alive in December 2008, we had a much better idea of what they would be worth. On the other hand, we know a lot less about the costs of hogs to be slaughtered and sold in June 2009.
You know you’re in trouble when an explanation leaves you more confused.
“I trade in volatility. I don’t care whether the market goes up or down—I just care about when, and how quickly or slowly, that happens. The market closed very high on Wednesday, Nov. 26—except for October, where the market flopped. We thought it was going to catch up and do the same on Friday, but it didn’t. I’m hoping it does today so I can unload these options at a good price.”
On this particular morning we were trying to sell 11 options to buy pork in October 2009—and just to make the whole thing more bizarre, the pigs in question haven’t even been born yet.
“Last week,” Aaron explained to me, “I was selling October puts—the right to be short, the right to sell and hopefully make a profit—I don’t like to have a bias on direction, I wanted to sell half as many calls as puts I sold. I sold 20 puts and I wanted to therefore sell 10 calls. On that day I had a hard time selling October, so I sold earlier months that were more liquid. June is a summer month and it’s more than six months away, so it’s going to act more like October than February or April—those hogs have been born, they know the conditions and [the prices] are starting to get locked in.”
I then asked: “Why are June, July, and October ‘liquid’?” Though I can now do Aaron’s explanation (“hogs expire”) one better:
Hogs are actual things—they are born, and fed, and fed some more, and then slaughtered. In my trading experience, February 2009 was a time in the future when an actual pig (“lean” because it’s been slaughtered and drained of all its blood) would be sold at a particular price—and February 2009 is much sooner than June 2009. In December 2008 a pig that will be sold in February was probably rolling around in the mud. (Actually, it was probably crammed into a pen in an overcrowded factory farm, but let’s permit the naive fantasy.) Since this pig and all other pigs that would be sold in February 2009 were alive in December 2008, we had a much better idea of what they would be worth. We know how much their feed has been costing, roughly how big they will be, and what it costs to light, heat, and clean the farm. On the other hand, we know a lot less about the experiences and costs of hogs to be slaughtered and sold in June 2009; therefore, we know less about the value of these animals. So, when Aaron says the June and October markets are more “liquid”—or open and flexible—this is why.
The bell on Dec. 1 sounded and the pit charged into action. Suddenly animated traders and brokers unleashed shouts, yells, and even growls. The activity was riveting even if I had no clue what was happening—probably because I had no clue what was happening.
But Aaron and I weren’t in the pit, we were above it, staring at an equally chaotic system: his computer screen.
Step 2: Begin Trading
There’s an explicit hierarchy in the pit. Brokers stand around the outer edge and take orders from traders and clerks, who vie for their attention. It’s a breeding ground for favoritism and nepotism, and typically rewards the loudest, tallest members of the group. The computer, on the other hand, is blind; but that doesn’t mean it’s always fair.
Charts wallpapered Aaron’s monitors. On the right monitor, throughout the day he would watch the offers being put in by other traders. Occasionally, he’d respond to an offer to sell or buy with his own terms—someone might want five December at 60 and Aaron, provided he had five December, could tell the computer he’d sell them at 65. His offer would show up on the left of his screen highlighted in blue and marked “Booked”; if someone agreed to buy his December lots, the row would read “Filled.”
While the consensus is that computers will antiquate the frenzied shouting and signaling of the pit, we’re not there quite yet. I returned to Aaron’s desk to find him cursing at his screen.
At the bell, Aaron turned his attention to the 11 lots he was trying to unload. October was still low, and the big question was whether it would rally or continue to fall. Almost immediately, an offer came in for one lot at “settlement,” or the opening price of 7437 (which is not $7,437—but more on that later). Aaron jumped on it.
While Aaron waited to see if he’d be able to unload the rest of his 10 October options, I chatted with Derek, a clerk sporting the standard gold jacket, when he wasn’t answering the phone and taking orders for lumber futures. Derek’s morning had been busy and the pockets of his smock were packed with trade receipts.
Derek works for a big investment firm, but when I ask what attracted him to the Merc he explained: “I want to learn to be a trader. I love the culture.”
“It’s hard to argue with a 9 a.m. to 1 p.m. workday, but isn’t the camaraderie dying out now that more and more people are in front of screens?” I motioned to Aaron alone, at the end of the row, wringing his hands.
“For sure it’s changing,” Derek acknowledged.
While the general consensus seems to be that computers will antiquate the frenzied shouting and signaling of the pit, we’re not there quite yet. I returned to Aaron’s desk to find him cursing at his computer screen.
“You know that trade I made? It didn’t go through. I made the trade at 9:17:51 and now I see someone else sold the lot to the buyer at 9:18:22. I spend so much money on this software. I’m trying to get ahead of the game, but it takes all my free time to even understand it. I could be doing better in the pit right now. Traders there make markets together, while I sort of tough it out on my own, but I want to get a leg up since I believe everything will eventually be digital. Looks like I’m taking the hit right now.”
Aaron got on the phone, complaining to the software company about his lost trade. A dark cloud had descended and we’d barely been at it an hour.
Step 3: Wait for the Corn Market to Open
“We need a fucking rally, boy.” Another clerk, Aaron’s neighbor Lynn, has the vocabulary of a football coach and the energy of a triathlete. She was studying a series of jagged lines in blue, green, red, and black on her monitor.
Everyone was waiting for the corn markets to open at 10 a.m.
Lynn would watch the corn market with fixed intensity, hoping that a rally there would set off a rally in pork. Because crude prices were down at the beginning of December—resulting in $1.49/gallon gas prices in some parts of Chicago—corn was in less demand. To the frustration of environmentalists and public-radio correspondents, no one was hard-pressed to invest in or support alternative fuels like corn-based ethanol with oil prices so low. Less ethanol means less demand for feed corn. Also, transportation costs for shipping pigs by ferry or truck are lower when crude is down. For these reasons, cheap corn and crude oil mean cheap pigs and cheap pigs make for less trading on lean hogs and a “bearish” market. Lynn uttered the word as she poured over her graphs, and Aaron as he played with his pen cap and absentmindedly read AM Chicago. The market that day was decidedly bearish, and that meant everyone was totally bored and very stressed.
Step 4: Scalping
Corn was not rallying. Pork was not rallying and crude remained low.
“I’m not just a volatility trader, I’m a long volatility trader.” Aaron again tried to explain his job. I was trying to find my bearings in the rabbit hole.
“I trade on the amount the market moves over long periods of time. Every day I lose a little money because I buy more options than I sell, and every day those options are worth less because of time decay. There’s very little volatility in December 2008: It’s going to expire in 11 days. The more time you have between now and the time the options expire, the better chance it’ll reach the levels I’d make money at.”
Volatility came up repeatedly during our day at the Merc, and a little question mark took up permanent residence above my head.
“It’s more complicated than I can really explain right now,” Aaron consoled me.
“Lately, whenever someone asks what I do it’s always, ‘things must be so bad for you with the market trouble.’ I constantly have to correct them and explain, ‘I trade in pork. My market did not collapse.’”
But learning about time decay, like liquid markets, helped remind me we’re talking about real things. The closer we get to the time when Aaron’s options would expire, the less they’re worth to him because he’s more certain about the selling price of a particular hog, which means more money he can stand to lose on that particular hog.
But Aaron has a way of compensating for this inherent loss.
“I’m constantly scalping—making little trades to try to sell higher than I’ve bought—selling highs and buying lows. At the same time, the money I make has to outpace the money I’m always losing to time decay. Right now, in this market, and today specifically, scalping is the only thing that’s keeping me from losing money. But when my time decay is slight, and the market is changing a lot, trading options on top of scalping futures can make me a lot of money.”
His clerk took care of most of the smaller trades and a broker would occasionally signal from the pit that he’d bought a one lot from Aaron.
Step 5: Try Not to Lose Money
“I’m lucky that pork isn’t deliverable,” Aaron laughed. “My buddy who trades corn futures once got stuck long and had to spend like $1,000 getting rid of the corn he couldn’t sell off by the time the shares expired.”
“Lumber is deliverable,” Derek chimed in. “But we work with so many lumber mills who trade futures so that they’ll have extra income to pay employees and develop their businesses during off months, that we never have a problem if we’ve bought lumber we don’t sell on the market.”
“Live cattle are deliverable. But with lean hogs, I’ll just get the closing price on the date it expires for whatever I’m still holding once my shares expire.”
Again: actual stuff. Lumber to build your house and pork to feed your kids. One share of lean hog futures represents 40,000 pounds of pork. One trading point equals one cent per hundred pounds, or $4.00 per point. When Aaron is scalping, he trades the future, not the option to trade. He usually sells or buys “one lots” of pork. That’s 40,000 pounds—a number I think is based on the amount that will fit in a train car, or some other kind of car that holds 40,000 pounds; honestly, I’m not sure. The opening price for a one lot of October 2009 hogs on Dec. 1, 2008, was 7395. That’s 0.7395 multiplied by 40,000: So the cost of a car of pork is $29,580. If we were to buy a one lot today we wouldn’t earn or lose anything until we sold it. Say we buy one lot at 7395 and the next day the market goes up to 7500. We’d make $420. The initial investment of $29,580 is not necessary, but if the price fell to 0 because of some freak event, we’d owe $29,580. So when Aaron’s options expire, the hogs are going to be sold at market price, whether that’s lower or higher than what he paid for them. He has no choice; the pork has literally “expired.”
Step 6: More Waiting
“I’ve still gotta unload these lots of October.” Aaron said anxiously at about 11:30 a.m. “I’m just waiting for a decent offer.”
His backer, a wry, good-natured, middle-aged broker named Brian, paid us a visit to commiserate over the slow market and dispense some advice in what might as well have been Swahili. Aaron told him about my article.
“Sorry it’s so boring here today,” Brian shook his head. “But it’s good you’ll be explaining options. Lately, whenever someone asks what I do it’s always, ‘things must be so bad for you with the market trouble.’ I constantly have to correct them and explain, ‘I trade in pork. My market did not collapse.’”
Lean-hog options might not have crashed, but they’re not skyrocketing either. “Open interest” is the total number of outstanding bets in a given month. If you buy a contract, you create open interest. If you sell that contract back, you reduce open interest. You’ve may have made two trades, but open interest would remain unchanged. Aaron showed me how to use this information to compare markets between this year and last year.
“Each month there was higher open interest a year ago: That’s a result of funds pulling out. People have lost so much money in other places, they’re pulling out of the commodities market.”
Playing the market may give a thrill and could make you rich, but being on the floor felt like the day before summer vacation: nothing to do but watch the clock and wait to rush anywhere but here.
Step 7: Closing/Settling
Just before the end of the day, Aaron managed to find someone to buy his share of October. “I even made $40. Not too bad considering the computer fucked up the trade.”
At 1 p.m., October 2009 settled at 7395, two points below its open.
Considering the sluggish and disappointing day, I let him off the hook on the promise to help me trade a one lot and was content to sit in his chair for a while, chew some of Lynn’s gum (“It’s like currency around here,” Aaron whispered), and leave with no financial investment in the market.
Back at Aaron’s office, we ran into Brian again. “You know, when you’re making money, this job is a lot of fun. But in this market, it’s almost like going to work,” Brian said, shaking his head.
Later that week, I got another opportunity to interrogate Aaron about his work when he took a break from the slow market and came to visit me in New York City.
“Dude, seriously, how the hell do you make money?”
“Trading on my options, I buy some stuff, and someone comes along and says, ‘I want to buy that.’ Ideally I only buy an option if I have a sell to lean on. If I think the 68 call is worth $2.50 and I think the 70 call is worth $2.20—the higher the strike, the lower the value of the call because the higher the value you’d have to buy it at—and let’s say there’s a resting offer—someone says, ‘I’ll sell you 10 of the 70 calls at $2.20,’ I don’t like the edge, I don’t want to buy them for fair value. Let’s say someone else came and offered $2.80. Then I’d sell the 68, and also buy the 70 because you always want to get out of your risk. Take on something for edge and take it off for fair value or even better than fair value. It’s about managing risk, getting out of it, while still taking a profit.”
“And you make a profit? Even though the market sucks, even though your holdings are always depreciating in value?”
“Sometimes I make a huge profit. At the beginning of this year, I thought I was gonna be a millionaire. Hasn’t ended up that way, but that’s how the business works.”
In an act I perceived as enduring faith in the financial system, he bought me a drink.