“My favorite things in life don’t cost any money. It’s really clear that the most precious resource we all have is time.” – Steve Jobs
If you happen to be reading this note while occupying a seat at a firm like Wolverine Trading or Peak6 or D. E. Shaw or AQR or any number of other mythological market creatures that we have yet to model, please don’t fret. We will get to you soon enough…
For now, we are going to leverage some recent modeling on Simplex Trading – a name not as well known (yet) as some of the others – to reinforce our plot (just in case some of you have lost sight of it in all of the numbers, vernacular, and other perceived complexities) and try to teach you something new about the market ecosystem we are all playing in or otherwise indirectly tethered to.
The plot here is reminiscent of the DaVinci quote we use with extreme redundancy for effect: “Learn how to see. Realize that everything connects to everything else.” For our purposes here, the translation goes like this: Realize that everything going on in closest proximity to the sources of liquidity – our structural alpha zone – is impacting and re-shaping everything in other neighboring segments of the market ecosystem – our active and passive management zones. To put it a bit more bluntly: just because we happen to be getting into some weeds on little-known option market making firms and secretive prop shops, YOU STILL NEED TO PAY ATTENTION! LEARN!
Furthermore, if we were to take the market ecosystem evolution to its limits; forward to a time when there is only the equivalent of Coke or Pepsi, Ford or Chevy, or some other binary choice caused by our current capitalistic model’s propensity to consolidate, then we are likely to find ourselves with a short list of alpha players and a short list of beta players like a “barbelling” of listed markets with crumbs of temporary, accidental and illusory forms of outperformance in-between.
However, in the end, the choice here will not be binary; it will not come down to Alpha or Beta. The choice for you and I will only be Beta. Because by then, Alpha – real, persistent, high-capacity alpha – will be fully privatized…
Ok, so who among the current list of alpha players are likely to be among the survivors as the market MACRO-structure continues to consolidate? I’ll answer by posing the following scenario: Prop Firm A wields a computational arsenal that yields high Sharpe Ratios in linear products, like stocks and ETFs. Prop Firm B wields a computational arsenal that yields high Sharpe Ratios in linear and non-linear products, like options. Who is more likely to survive? (The non-linear guys. As market makers, they simply have more spreads to play with.)
Hence, our – albeit temporary – focus on the leading options trading firms. We will eventually turn the page to expand our focus into other types of asset managers, but for now it’s too important to quantify the overall size (and rankings) of the players in our structural alpha zone – at least for US listed products.
We will have much more to say on this as we go forward, but for now let’s return to the topic at hand:
Similar to prior modeling efforts, sometimes mythology and data don’t match up. In the case of option market maker Simplex, however, there wasn’t much mythology that preceded our peek into the data. Founded in 2004, this group has remained exceedingly quiet; a Chicago hallmark.
So, with this brief lead-in as backdrop – along with the idea that 13F position counts north of 5,000 for a small prop firm with headcount south of 100 is quite notable – Alphacution starts this one in the exhibit below by presenting the total 13F position counts for the full 18 quarterly reports beginning Q4 2014 and ending Q1 2019.
Certainly, a prop firm with a single legal entity reporting ~8,000 long positions is a notable feat, particularly given that we know there is a sizable short side to this book (which we will get to in a minute). Most other trading and asset management firms achieve this level of position count by combining the positions of several legal entities under a single reporting entity.
Another notable aspect about the chart above – perhaps a clue, but perhaps an illusion as well – is the stagnation for the past 4 quarterly reports of total positions around that ~8,000 position mark. Since we are generally concerned about market capacity – and the product inventory that supports that theoretical capacity – we often wonder about whether a firm has maxed out the products that it is able to trade, given its strategy.
This is where position segmentation by product class comes in handy. In the exhibit below, Alphacution presents its breakdown of Simplex’s total 13F positions for the full 18 quarterly reports beginning Q4 2014 and ending Q1 2018:
Here, we can leverage information about long positions combined with experience about how an overall option market making book is constructed to estimate total long plus short position count: Option market makers are going to be long and short premium within each option matrix. Simplex trades in ~3,000 option matrices. The 13F report shows long positions in ~3,000 calls and ~3,000 puts. We can be fairly certain that there are corresponding short premium positions in calls and puts for the same ~3,000 names as well. We might also guess that there are 1,300 – 1,500 short stock positions (because 1,600 longs plus 1,400 shorts equals ~3,000 option matrices that all have associated underlying positions – and with further digging we could actually list those names for the date of the 13F report) and ~100 short ETF positions (because, while not shown, Simplex is currently carrying ~300 ETF option positions in calls and puts).
So, if you are still following along at home, office or from the train, Alphacution can estimate that Simplex has 7,930 + 1,400 + 100 ≈ 9,430 positions from the 13F securities list.
Now, one more thing before we wrap this one up for the night: We got around to taking a first peek at the 13F securities list published quarterly by the SEC for Q1 2019. Of the publicly available data on the SEC website, which begins Q1 1996, the 13F securities list of Q1 2019 yielded an all-time high, on an unadjusted basis, of 17,707 (see below):
Now, if you look at the recent stagnation of total 13F position counts for firms like Simplex, it betrays a roster of products that has recently achieved all-time highs. And though the following needs to be taken with a grain of salt since it has yet to be fully vetted for accuracy, when we construct an adjusted index that reflects added and deleted securities, the line moves in a surprisingly southern direction – which might explain some position count stagnation.
Food for thought.
If we’re wrong, we’ll correct the record.
In any case, watch this space…