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In this episode I talk with Noel Smith, Chief Investment Officer & Founder at Convex Asset Management as well as Volatility trader, Darrin Johnson. 

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We talk about How to Turn Pro as a Trader, How to Join a Prop Shop, How to Run a Prop Shop, The Business Side of Running a Trading Business, How to Build Relationships from Scratch and more! 

I hope you enjoyed this conversation with Noel and Darrin as much as I did!

 

 

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Have comments about the show, or ideas for things you’d like Taylor and Jason to discuss in future episodes? We’d love to hear from you at [email protected]

 

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Transcript Episode 39:

 

Taylor Pearson:

Hello and welcome. This is the Mutiny Investing Podcast. This podcast features long form conversations on topics relating to investing, markets, risk, volatility, and complex systems.

Disclaimer:

This podcast is provided for informational purposes only, and should not be relied upon as legal business investment or tax advice. All opinions expressed by podcast participants are solely their own opinions, and do not necessarily reflect the opinions of Mutiny Fund, their affiliates or companies featured. Due to industry regulations participants on this podcast are instructed to not make specific trade recommendations nor reference best or potential profits. Listeners are reminded that managed features, commodity trading, forex trading and other alternative investments are complex and carry a risk of substantial losses. As such they’re not suitable for all investors, and you should not rely on any of the information as a substitute for the exercise of your own skill and judgment in making a decision on the appropriateness of such investments. Visit mutinyfund.com/disclaimer, for more information.

Jason Buck:

So this one’s likely to never going to get published due to compliance reasons, but let’s record it anyway. For those of you not watching the video, that are just listening on audio. Hopefully you’re used to my voice now. This is Jason from Mutiny Funds and I’ve got both Darrin and Noel with me. And so just from the voice sense, maybe we will kick it off with Noel first. But the idea was, Darrin and I were having a discussion about what’s it like to be a DIY trader?

Jason Buck:

And like, how do you raise assets if you wanted to, or more importantly, how do you maybe go work for a prop shop or what is it like to own a prop shop and then search out those traders? And I just thought, you know, why not instead of us having a private conversation, let’s try to record it. And this could be valuable to hopefully a lot of people assuming well, we ever publish it. So maybe Noel, maybe I guess, maybe the quick thing maybe would be just give a background on your prop shop experience or, and then your trading before the prop shop. So that maybe, that’ll give us kind of a jumping off point.

Noel Smith:

Sure. So I started prop trading in 96. I was a stockbroker for about 18 months before that. So that’s how I figured out what time the stock market opens and that kind of stuff. But when I was initially a prop trader, I went to go work for a guy that spun out of Susquehanna and then Stafford. And I was basically the guy that went and got coffee, got tacos and all those other super sexy jobs. And that was it. And prop trading, for anybody who doesn’t know is simply trading your own money. It’s like, a glorified version of you on your Robinhood app, just trying to figure out which way Tesla’s going to go tomorrow.

Jason Buck:

Right. So part of that is, and you and I were just talking right before Darrin jumped on, is over the last decade, I personally have been always like googling prop shops and figuring out, how could I work at a prop shop? All of those things. And there’s just zero information out there. Or there’s a lot of BS information where almost like, you have to buy your seed or buy your draw down kind of thing where it’s like, kind of pay to play. So I guess the first question and Darrin, you’re going to be much better asking questions about this stuff is like, if I am a prop trader and I’m just like trading, you know, out of my basement or at home, and I’m doing very well for myself, like, is there still any legitimate prop shops left? Or like, how would I even think about getting in touch with them? And like, what is that, what does that process even look like to begin with?

Noel Smith:

So, ah, so I’ll give you my answer real quick. All the major firms that you would probably don’t even think are prop shops kind of are, like Citadel. We pick on them because Ken Griffin buys a giant house every other week. So he gets a lot of press, but there’s Citadel Asset Management, which is the hedge fund. And then there’s Citadel Securities, which is really just a prop firm. It’s the same. Susquehanna’s the same. Jump is the same, there’s tons of them. But the reason that you don’t know anything about them is because, they don’t want you to, there’s nothing in it for them. So this is actually boomeranged back on me as somebody who’s launched a hedge fund because, I’m 52 years old and nobody’s ever heard of me outside of the prop trading community.

Noel Smith:

So when I talk to people about raising money or whatever else like, “Never heard of you guy, I don’t have any idea what your background is.” But because of that, I mean, I haven’t had a social media until like 18 months ago. I’ve had nothing. So you really had to try pretty hard to figure out anything about my background, but that’s been deliberate on my end. I’ve actually gone through great pains to not be a public entity on any level. And that’s how a lot of platforms are because it really doesn’t help them. And frankly, it can probably hurt them for anybody to really know what it is they do.

Darrin Johnson:

Even as an independent retail person, that’s the thing you run into when you start researching for propr shops is that, it’s almost like… To use the sports betting equivalent, it’s almost like a Billy Waters type syndicate, sort of cottage industry where it’s like nobody really knows. And then when you ask or you try to go through the sort of legitimate channels, there’s nothing really mentioned about it and the stuff that is available, like you said, there’s one firm in particular, well there’s two but they kind of merged that I won’t name on the podcast, but they call themselves prop. But, they’re making between seven to eight figures off of an educational arm, where people are paying for everything from learning how to day trade and scout stocks to income trading. And that’s what, and that’s positive to retail, who doesn’t know, who’s naive, who’s ignorant as an opportunity to be on prop desk and not to say that those firms don’t prop trade.

Darrin Johnson:

I know, though the parent company went through a pretty serious SEC audit, they are trading and they’re making really big money, but just like in the actual prop world to get into one of those coveted seats and get a decent size line as an individual trader, it’s basically just who you know.

Noel Smith:

Yeah.

Darrin Johnson:

I just felt like the… But the hunger games advertising the info products is just so gross to me. And it’s so disgusting because these are people who are already under capitalized. And then you’re going to ask them to put up six, seven, eight, nine grand for a course, for the potential to just, to potentially start off as basically like a clerk or an assistant on your desk, which they’re located in New York City in a very expensive place. So it’s… You just start thinking about it and you follow you say, “Oh, okay. They just don’t want. This isn’t a serious thing.” So yeah, from the retail side, everything that Noel said like, is absolutely… It’s been verified based on my research.

Jason Buck:

Noel, do you think maybe that’s a good place to start for, we’ll call it retail. We’ll just keep calling it prop traders maybe throughout this, is like, if you’re doing it yourself as a prop trader and you’re looking at maybe a prop firm, one of the initial red flags is maybe and you might disagree with me. It’s like, if they want you to pay for your education or they want you to put up money for the draw downs, because then typically aren’t they then in that scenario, they’re teaching you how to trade strategies that have high churn because they’re making a huge spread on the commissions. And that’s actually where they’re making money as a firm with all these quote unquote “prop traders” that are actually trading so many times a day that they’re just churning them out and then they’re just burning through the commission trade. What should people-

Noel Smith:

Yeah.

Jason Buck:

Let’s start with that. What are the red flags?

Noel Smith:

So I don’t want to speak out of ignorance. I haven’t looked for a prop trading job in a very long time. So it is not fair for me to comment on with the landscape that you guys are talking about, because I’ve this… This pay to play notion is, I’m aware of it, but I’ve never had to deal with that. I don’t know of any real prop firms, they’re going to ask you to write them a check. Zero. Hard zero.

Jason Buck:

Exactly.

Noel Smith:

They will ask you to get tacos. They will ask you to sweep the floors. They will ask you to scrub the whatever, and they won’t feel bad about it, but they will not ask you for money. So if you want to go get a job at, I don’t know, Susquehanna, they’re not going to ask you to write them a check. They will give you money and they will ask you for tons of effort and a very large commitment.

Jason Buck:

But if you’re talking about like the SIG, the Jump, PEAK6 of the world, they’re typically training their own traders-

Noel Smith:

Yes.

Jason Buck:

Getting them out of college right, and kind of raising them up. So what are the options for somebody that actually has a P&L and then also, how would you think to get your P&L accredited by some sort of third party entity, is also difficult where people even look at it.

Noel Smith:

Yeah. That’s common sense though. So you show up with your P&L and you say, “Okay, I have IP and I have no money,” or “I have money and IP”, which is the best combination. But if you can convince somebody who’s got money that you can make them money, you can probably get a job. It’s very hard to do that because a lot of the guys that are in the hiring position for prop firms are exceedingly smart. They’ve seen it all. They’ve heard all of the nonsense stories and those jobs are hard to get, but they pay really well. I mean, there’s people, one year out of college that are making six, 700 grand, and you’re not going to convince somebody to give you that kind of money, unless you can octuple verify everything you say.

Jason Buck:

Which is really hard to do, getting a verifiable track record, right? When you’ve been trading on your own. Sorry, go ahead, Darrin.

Darrin Johnson:

Yeah, no, I was going to say that’s really hard. And then on top of that, the stuff that you’re doing as an individual retail guy, even on a prop firm, which to me is kind of like just swashbuckling, whatever edge there is across global markets, whatever your edge is, right? Even in for that type of formalized entity, a lot of the stuff that you do as a retail person may not even be a good fit or scale to those operations, let alone like a traditional hedge fund or a bank desk if they exist anymore. So that’s the other thing is, as a retail person, is what you’re doing tractable and portable enough to be able to fit into even a prop desk, which is pretty liberal in terms of what you’re allowed to trade and the edges you can explore?

Noel Smith:

Agreed.

Jason Buck:

And part of that is, Noel correct me if I’m wrong. And maybe this is kind of where Darrin was headed to, is historically, and I may be incorrect about this, but a lot of prop shops had a really tight stop losses. If you blew out 5% on the year, you’re just shut down. So you had to have very conservative strategies and then maybe you’re using house money as you start to increase your P&L, is that still the case? Or are they… Allow a wide swath of strategies? Because a lot of times, if you had a more longer term convergent strategy, there was no way you were going to ever work at a prop shop because your draw downs would blow you out like immediately.

Noel Smith:

Yeah. So that’s true and not true. The public answer is that it’s true.

Jason Buck:

Okay.

Noel Smith:

It’s not true in the sense that, I’ve personally backed over a hundred guys, so let’s just say we have guy A and guy B. Guy A makes money and guy B loses money, but then you call them into your office and you say, “Okay, guy B why’d you make money, why’d you lose money?” And there is some sense of just common sense to this. Did the guy who lost money, was he just unlucky? And is his strategy otherwise still a good strategy? And the guy that made money, did they just get lucky and make a bunch of money? Are they just yellowing a bunch of Tesla calls or something. I’ve been mad at guys who have made money and I’ve been happy with guys that have lost money because they’re doing it for the right reasons. And their process is quantifiable and repeatable. So that’s the answer. And so if you’ve got a guy that lost 5%, but you know he’s doing it right. You’re going to give him a pass or you get another guy that’s down 1% and he’s a goofball shows up late leaves early, adios.

Jason Buck:

So back in the day, when you were in Chicago, was it just the serendipity of who was in your building? You could find individual traders there. How did you actually source these hundred guys? How did they even find you? How’d you find them?

Noel Smith:

So initially it was guys that wandered in my office, you know, knock, knock, knock, Hey, can I have a job? I worked for PEAK6 down the hallway, or I worked for Wolverine up a floor and so that’s a real thing. But the really good P&L generators, the earners, they’re not knocking on doors. It’s the guys that have blown out or just can’t make money or whatever else. So generally speaking, it’s through a… It’s just like anything else. It’s through a conduit, somebody you know in common. And then when we wanted to hire a new crop of people, I would personally go to universities, like universities we all know about and interview people and I’ve interviewed thousands of people and with varying success.

Noel Smith:

So we would hire people out of college and I’ve got a million interview stories, some really funny ones, but generally speaking, we would have a first or second interview on campus with a junior guy that would get escalated up to me. We would do a battery of questions and quizzes. And if they didn’t have any trading knowledge, we would go into math and stats and probability, and then just general knowledge about things in the world. How many fish are in the sea? I mean, those are real questions and those are… But reasoning through these questions gives you a window into their process and logic. And then you figure it out and you make a decision.

Jason Buck:

I know you just used Darrin’s favorite word earners. So I know he’s happy just having this conversation. Darrin probably uses earners like every other sentence when we talk. It is like, is somebody a good earner? But, has that changed in modern times? Would almost the vice be a good set of luggage? Should you just move to Chicago, hang out around the CME and the CBO and all those bars that are around there, as soon as the markets close and maybe hang out in those bars and just start to get to know people, or like… What would be the, what’s the wedge for anybody currently, in 2022, to try to get into a prop firm?

Noel Smith:

I don’t actually think it’s that hard. So the idea that you have to hang out at the preferred bar or whatever else, most of the people really making decisions, aren’t usually degenerate alcoholics or whatever else. I mean, guess that exists. But generally speaking, the real people making real money are smart, real people, and they work hard and they do their thing. So if you have a verifiable track record, you can pre answer every question that somebody’s going to want to know, which is… The really, there’s only one real question. How do you make me money with as little effort on my end? I want to do nothing. And I want you to be in my life and make me money. That’s it.

Noel Smith:

Everything else is just like nonsense. And it adds to the complications, but all you want to know is, will this person make me money? Yes or no. Next question is less important. But if you can prove to somebody that you will make them money and cause them no hassles, no compliance issues, no just stupid drama. You can get a job. And if you can just get in front of those logical questions, which is make it as simple and easy for the person interviewing you as possible to give you money, they will give you money.

Jason Buck:

Right. But part of that is though, I agree with everything you’re saying. That’s perfect. But the question still remains is actually the very first step is how do you even find those people to get in front of, to show you can make them money, right? That’s the rub, right?

Noel Smith:

So I’m a bad person to ask only because I already know. But if I didn’t know anybody, what would I do?

Jason Buck:

Right.

Noel Smith:

Just pound LinkedIn or something like that. So if I saw this interview, right, I would see this interview in a week. I would LinkedIn all three of us and I’d be like, “Hey man, I’m a no nothing guy that knows nothing. But by the way, I got a great P&L and I’m happy to have it audited. I spent six grand of my seven grand to send it to Ernst & Young and, it’s got the stamp of approval. This is all legit. I will go to the maths on this idea. All I want to do is give you a chance to show you how I make you money.” Look, okay. I’ll take a look.

Jason Buck:

Please send those DMS to Noel and Darrin, not to me. But that’s part of it though, my next question on that Noel is, historically too, do you want people that are trading a singular strategy or can they have a broad set of strategies? Could they run an ensemble approach? It always seems like prop shops is one instrument, one trade or is that fallacious?

Noel Smith:

Yeah, it is definitely fallacious. If you are in a situation where you don’t know anybody in the business, there’s no way you know 10 good trades. If you have been lucky enough to source out Japan versus Germany versus Iceland versus Mars, and that’s somehow the way you make money, it’s taken you a lot of time and a lot of effort to figure that out. And if you’re the only guy in the planet or a small subset of people that know how to do this, there’s just no way you also know 25 other trades. It just, it’s not possible. If you’re a heart surgeon, you can’t also be a rocket scientist or whatever.

Noel Smith:

There’s just too much information in any one person to do all that stuff. Now, those are extreme examples, but you can learn these things in time. But if you don’t, if you already have that much skill, you already have a job. And how you get that information is you go get a job at Susquehanna using them and they put you on the bond desk and then you do a good job. And then a guy gets fired on the gold desk and you go learn gold. Then you go learn oil. Then you go learn equities. That’s how you get that breadth of knowledge, but you’re not going to teach yourself that stuff. It’s just too hard.

Jason Buck:

Yeah, that was kind of my question is like, you show your competence through one trading strategy, and then when you’re getting in there, you’re getting mentored on all these different desks. And you’re going to ask all these different questions and you can learn how to broadly apply your skillset, is kind of the way to think about it?

Noel Smith:

Yes, that’s exactly right.

Darrin Johnson:

But even still, what if you’re like a former group one junior trader and you’ve been making markets on 30 different single stock equities. I would think that would still be difficult to switch over to the quote unquote “hedge fund” side of set it up, right?

Noel Smith:

Yes.

Darrin Johnson:

Because it’s a… So in other words, you’re filtering and filtering and refining and filtering until you get a very small subset of traders that can actually fit within the prop framework. Because former market makers, I mean, some of them could I’m sure, but a lot of them are horrible position traders. They really only know mispricings and quasi arbitrages right? Not necessarily position, taking a position. So if you think about from the [inaudible 00:18:14] perspective like, these guys really came in, not really having an opinion on volatility, they’re just kind of aware of it.

Noel Smith:

You’re totally right. Imagine like, you zoom into a little pond in your neighborhood and you zoom in close and you see two paramecium battling with each other about a little speck of algae or whatever. Right? They have no idea that there’s a fish over there and they have even less of an idea that they’re in a pond, where this pond is one of a thousand ponds. It’s in a state that’s in an island or whatever. So you’re right. So if you are a vol guy making markets and 30 different names on group one, you maybe know something about the vol surface of Tesla, but that’s about it. And you know how to use the software that they’ve worked on over the last 20 years. But why is Tesla going up or why are bonds going down? You have no idea.

Darrin Johnson:

Yep.

Noel Smith:

And it doesn’t scare.

Darrin Johnson:

Which is why, by the way, parenthetically, why so many of those guys are again, won’t drop any names, but have been selling income courses and income calendar, in triple income calendars since 2001. [inaudible 00:19:20] They left the CBO floor, were backed either by group one or some of the other larger firms down there on the CBO floor. And then they just pivoted to options income education. And that’s their new business. I mean, you can’t knock the hustle. It is what it is, but they didn’t go prop for a reason, you know?

Noel Smith:

Well, I mean, Groupon is a prop firm. The problem with the hedge fund world is that in some ways it’s more sophisticated, in other ways it’s less sophisticated. But the main problem is how does it scale? Because if you’re out there making markets in 30 Delta puts in Tesla, I mean, you can’t do that with a billion dollars. You can barely do that with 10 million. That’s about it. And by the time you actually lever up these $2 options, you go out buy 2000 of them, the market figures out who you are and they fade you as they should.

Jason Buck:

So part of that before I get to almost the flip side of what’s it like owning one of these firms and thinking about the way you did with aggregating a lot of capacity constraint strategies, let’s just say like, hypothetically, you had a prop trader that’s been trading out of their own house or WeWork or something like that. And they’re running single digit millions and maybe their capacity is maybe 10 to 20 million somewhere in that range. And they’ve been having a great P&L, but as you know, if you’re doing that, your P&L is also attributed to your personal life and everything. So it makes it a little bit more difficult. You can’t be as unemotional about it. What are the kind of pros and cons to going to work at a prop shop? Is it a good idea? Does that person just keep running their own book? Maybe it’s not even a good idea for them to go to a prop shop.

Noel Smith:

Depends on the pay right? It depends on the scale.

Jason Buck:

Yeah.

Noel Smith:

So I mean, if you’re running a hundred thousand dollars strategy and you know you can scale, you know, a thousand X then. Yeah, sure. But if you’re, you know, you’re trading something quirky, like soybeans at three in the morning, you know, they can, they can give you $5 million, but you might make a million or two, and then you get your, your cut. So maybe it’s not that great. And you know, that is true. Especially within the future’s world, a lot of guys have great PNLs and their sharpe is really strong, but they just don’t scale. I mean, if you actually have real big boy money.

Jason Buck:

Right.

Noel Smith:

You can’t put it to work, so you’ll blow them out so fast that they don’t even know what to do about it. So there are a lot of problems with that, but it ultimately it boils down to, what is your strategy? Does it scale? And, does it scale at the terms of the deal? And only the individual can make that decision.

Jason Buck:

What kind of scale would you be looking for? Are you fine with something that’s sub 20 million in capacity because you can combine it with your hundred other guys, is this fine by you?

Noel Smith:

Yeah, totally. So, if you have a guy that’s trading Exxon, another guy that’s trading Chevron and they don’t know how the other two work, you can cross collateralize those ideas. Or if you’re in the future’s business, so you only need to put up a certain amount of maintenance margin. And then you can put your gold guy against your beans guy against your fixed income guy. And you actually maybe need to have $10 million on deposit at the firm, but you are actually controlling something like a hundred million or maybe a little bit more. So those are all very realistic things that you can do, and you can do it less so within the equity space, specifically equity options, because the risk limits are going to be different. Assuming you have a prime relationship someplace real like Goldman or ABN where they give real margining. The methodology is known and yeah, it could be totally worth it to you.

Jason Buck:

That was actually, you just front ran where I was almost headed next, which is perfect. But also before we get there though, you also reference like the trader can make their cut from the prop firm, just like ballpark, what’s like an average cut? Is it just a percentage of incentive? Is that, and I mean, is it baseline salary plus incentive? I’m sure it’s kind of run the full gamut, but give us an idea, that color around like what is the actual, even the cut going to the individual traders.

Noel Smith:

So in the beginning, if you’re watching this interview, I assume you don’t already know most of these questions and answers. So I’m assuming that you’re a junior trader. With that assumption, it’s going to be something like 10 or 20%. It could be higher, but if it’s higher, that means it’s a smaller trade. So if you’re getting stuck on the bond desk, which is going to be a big number desk, they’re not going to give you 50% of the bond trade. There’s just no way. Because there’s billions of dollars there. So you’re going to get a small little chunk. But if you’re on the lumber desk, which is pretty thin and have been volatile, you get 30, 40%. Sure because it’s a smaller trade, but and the numbers are, usually low six figures to low seven figures. Is it realistic that a prop trader makes a million dollars their first year? I mean 10%. Is it realistic that a prop trader makes a million dollars within three years? Yes. That’s quite very reasonable.

Jason Buck:

Yeah. It is dependent on your allocation size and then, I’m sure as you become more and more successful, you can negotiate more of your incentive fee on the back end.

Noel Smith:

Of course.

Jason Buck:

But just so I know, is there any sort of base, almost minimum wage salary or is that just non-existent? Just so people know at like a…

Jason Buck:

Based like almost minimum wage salary or is that just nonexistent? Just so people know at like a legit firm.

Noel Smith:

Yeah. I think that the bases are something like 150 to 250. I know the…I know that even interns at some of the good prop firms are making more than that. So, you know, I know some firms out here in California that, you know, starting salary is like 500, but you know, these people that are getting these jobs are not dingalings. I mean, they’re very smart people.

Darrin Johnson:

Right. Yeah. That’s, that’s the key thing. I mean, Jason and I have a mutual friend who is at one of the big, big, big funds and he has his own book it’s quite substantial, but he’s a freaking mathematician from Georgia Tech.

Noel Smith:

There you go.

Darrin Johnson:

You know what I mean? Like he is, he is out of this world smart and he’d had proper experience prior, you know, before getting this, this now recent job. So, I mean, these are like the brightest and best people.

Noel Smith:

Absolutely. I was talking to these two guys from China here in my office in California and the one guy’s like, you know, Hey, this guy’s the math champion. I’m like of what? He’s like China. I’m like, what do you mean? What’s he like, no, China. I’m like the whole, the whole place? He’s like, yeah, like that’s pretty hard to do. I’m like, yes, that is very hard to do. To be the number one guy in math, all of China, no joke.

Jason Buck:

That’s like straight out the big short where they had the number two guy, was it when he was the runner up or something and then the Chinese quant. Right. So Darren, do you have any other questions on that side that you had been marinating on before I kind of almost flip it around and talk about what it’s like to own a prop firm. Like from the trader side.

Darrin Johnson:

The only thing I was wondering about was in your experience with interviewing and then managing hundreds of traders or whatever, do you find that most of the guys that work out well come from the future side, futures and options, or from the equity side?

Noel Smith:

I don’t have an answer to that question. The answer to the question that you didn’t ask is what is the, what makes somebody work out? It is moral ambition. What I mean by that is somebody who is, you know, an initiative taker, somebody who does their own job as best as they can, and they also want to be there. So you can be moral and you can be ambitious, but you could do things the right way, and you demonstrate a work ethic. That’s kind of a corny answer, but it’s dead true. I mean, I’ve known guys that are much smarter than other guys, but they’re kind of like, yeah, you know, I don’t really want to be here and they fail. And then you got guys that are maybe not as smart, but they’re like really trying to learn everything. Those guys have a much greater track record.

Jason Buck:

It’s amazing how you would think that like in our business, it’s all about black and white P and L, but all the dynamics from life still work out, like be a nice person, work hard, show up early, leave late, and everybody will give you the benefit of the doubt and everybody wants to help you out. Like, it’s really that simple. Huh?

Noel Smith:

It, it really is true.

Jason Buck:

Hmm. So I was…The impetus actually from this was, I was actually talking to Darren. I was like, you know, have you ever thought about starting a prop shop? So let’s kind of talk about that other side of like, what would it look like to start a prop shop? Like what you initially just talked about earlier that I think is one of the most fascinating things is like, if you have the proper relationships that you can actually run, you know, you can cross marginalize and run a lot more capital and that’s the point of the prop shop. Is it kind of almost set up…Like in a way I think about it, like when you want to start a bank, you get a bunch of people to put in equity in the bank and then obviously out of whole cloth, you know, banks create loans, but instead you could get maybe a few investors together, raise 10 million bucks, but then you could be running a hundred million book across, you know, multiple traders in multiple strategies. Is that like overly simplified or what would that look like from a setup process?

Noel Smith:

No, I mean, no, in theory, that’s not too far from what happens. So in the future space, it’s a double edged sword. It is easier to do, but because it’s easier to do, it’s harder to make an edge. And in the option space, you know, it is, or the equity option space that is it’s harder, but it’s harder to do and it costs more money. So it’s like, you know, do you want to be in the quirky business with all kinds of edge that nobody else does, that’s hard to get into? Or do you want to be in the easy business that’s easy to get into, but everybody else can do it, so there’s no edge, you know, and it’s just kind like common sense. So futures trading in general is, it’s cheaper, it’s easier and it’s easier to get into. But because of that, you know, you need very strong IP to make money. If you’re going to out compete, Optiver in the future space you need to know what you’re doing.

Jason Buck:

Yeah. So part of that though is like, so you put a couple million in equity in, you get the right prime relationships, which are sometimes harder than people realize, and sometimes it’s a certain size. Do you know if like, you know, if it’s GS or ADM, like they’ll come down in size or do you think it’s usually a hundred million, a hundred million in notional is usually the minimum or?

Noel Smith:

Nah, they, they say that, but that’s not true. I don’t want to get Goldman to yell at me cause I have a relationship with Goldman, but you know, the number is lower and if you’re a real person they’ll come down.

Jason Buck:

Right. So let’s just say, hypothetically, and I’m using the air quotes here for those listening in is like, if somebody like Darren or I wanted to start like a prop shop and let’s say we aggregate five to 10 million bucks in cash, and then you’re running at like 25 to 50 million let’s just say across the entire book, how would you then, you know, in the modern times, it’s very different from Chicago physical space, maybe back in the day where now you could probably source people from around the world online. And, but then how do you start to…How would you think about getting the first people in? And do you think about…You wanted diversification of strategies to make sure like you’re not blowing up because you are running that notional leverage across your book?

Noel Smith:

Yes. So kind of like what you do with Mutiny is very sensible and you and I have talked about this privately, you know, how… Where you got to where you are and where I’ve got to where I am, you know, the paths are very different, but the end game is not that different. So we’re looking for non-core latest strategies that make money all the time, no matter what. And ideally you have 10 strategies, 10 make money, you know, more realistically you have five strategies that go up five strategies that go down and the correlation is fairly low and they make money in aggregate most of the time. But, in terms of how do you find that you have to have the, you know, it doesn’t require that much mathematical heft, but you have to know how to, you know, figure out what’s related to what and how those relationships change with time.

Noel Smith:

So, you know, it’s, you know, the correlations aren’t static, right? They’re dynamic and they’re spurious. So you need to know that and how they change, and when they’ll be at the highest pain inflection point. And that’s, I guess probably the easiest thing to do, but getting these relationships as you pointed out, you know, if you just walk into Goldman Sachs and say, great, I’m here with my five million dollars. Can I have an account, please? They’ll say no. But you know, but if you can convince them that you’re going to make them, you know, a couple hundred grand a year, no less, make them, not you. I mean, a couple hundred grand a year doesn’t sound like much, but when you’re paying out 9, 10, 11, 12 grand a month in fees, and you’re like, oh, man, this kind of sucks, adds up. And, but they don’t care. Their business is their business, not yours.

Jason Buck:

It made me think about it in a different way, because like I asked you the question earlier and all that like, you know, what do you do if you don’t have any relationships and you answered that perfectly like via this podcast, LinkedIn, that hustle, right. You just need some sort of wedge.

Noel Smith:

Yeah.

Jason Buck:

And the same thing has happened to me even like, so I can’t even deny it, I’m like, if you want to find a good prime like Goldman or whoever it’s like, you just start hustling relationships.

Noel Smith:

Yes.

Jason Buck:

And over time you can…And then like you said, you look for what’s their incentive. How do I talk to them in the right way? And you’re going to get turned down a lot of times. But just even like back in the day when I talked to bankers for commercial real estate, I would get, I got turned down probably 35 times before I got my initial commercial real estate development loan.

Jason Buck:

And every time after they would turn me down, I’d go, Hey, I’m about to go across the street to this other bank. You know, what did I do wrong? Help me like improve my pitch, you know, what can I do differently? And they were always more than happy to help. And so it’s kind of like there, it’s like, everybody’s like, well, I don’t know where to start. And it’s like, you just need that first wedge. And then you just hustle your way into it in a way. But like, so when you’re, when you were looking at traders, did you have like a…

Darrin Johnson:

Wait hold on, hold on. Jason I don’t mean to interject, but…

Jason Buck:

Go ahead, go ahead. Please.

Darrin Johnson:

I just…There’s something that’s sort of implied here that I think we shouldn’t just gloss over. You have to have acquired the back office and compliance knowledge from some…About how prime relationships work, how across margining works, how sub-accounts work. In other words, there’s a regulatory nuts and bolts piece that the person going into this is assumed to have, not in addition to the cash or the capital. Right? Like, and so when you talk about issues of, okay, where do I start? Well, again, it’s kind of like, I always say like, it’s knowing the end at the beginning. Like you would have to have, you would have to know what you need to know in order to even get your organizational structure correct. Right.

Darrin Johnson:

Because like, what if you, what if you’re a guy and you, and you know, you, whatever, you cashed out a crypto and you have 20 or 30 million dollars, but if you don’t know that you needed a certain prime relationship and then there needs to be a certain amount put up for a haircut, and then the other portion of remaining capital needs to be kept at a specific type of bank, right? Like there’s all these different steps that people need to get familiar with, and again, this is why to Mo’s point apprenticeships, internships, you know, doing admin stuff at one of these firms is valuable. It’s primarily for the business hygiene, 1 0 1 stuff .

Noel Smith:

Spot on. I think you’re totally right.

Jason Buck:

Yeah, I couldn’t agree more with what you’re saying, but you also know my history too is like, I didn’t have any of those relationships. I didn’t have any of that apprenticeship and mentorship and what’s I do? I just started picking up the phone and asking a lot of dumb questions to a lot of people who told me to like go kick rocks. And I was like, wait, wait, before you hang up, tell me the…And like, and then eventually you start putting those pieces of the puzzle together. So it is doable. It’s just, it’s going to take you a long time and you’re going to have a lot of, you know, like false starts and you’re going to go down a lot of blind alleys and you’re going to turn around and everything. So I mean, yeah, I mean, you’re getting information here from this podcast. You Google, you start calling people, you start asking questions and you just can’t be afraid of getting your door slammed in your face and told you’re an idiot. Right. I mean, that’s, that’s what it boils down to.

Noel Smith:

So you’re, you’re both totally right. You know, there’s, there’s the business of the business and then there’s the trade. Right?

Jason Buck:

Right.

Noel Smith:

So that’s what…I have a COO Brian and you know, his job is to make sure that the business has, you know, followed up on whatever items of business you need to do. So to Darren’s point, you know, you need to figure out all the stuff you don’t know. And if you can’t get an account at Goldman, you don’t, you go to interactive brokers or you go to Wet Bush, or you go to one of the smaller prime brokers and then you figure out right where are they jamming me on fees, where are they negotiable on fees? What does it mean to me? And then after you do that for some period of time and you have a, maybe a bigger, better account, then you can walk into a Morgan Stanley or Goldman and say, Hey, I’ve, I’ve had an account at Wet Bush for the last three years, you know, Bob over at we Bush thinks I’m a good guy. Can I have an accountant here too, please? Thank you.

Noel Smith:

And then to your earlier point, Jason know how do you start? I mean, I remember at, you know, in like 2000, I wanted an account at Smith Barney. I wanted a relationship with Smith Barney. I didn’t have, didn’t have an account. This is before Smith Barney went away, and I remember walking up to the guy on the floor of the American stock exchange. I’m like, Hey, I’m Nole Smith. You know, hi Joe, nice to meet you. I wanted, you know, I want to look at some of your flow. I want to look at some of your flow business. He’s like, get out of here. I don’t know you. And I just completely blew me off. I’m like, I don’t, I don’t expect anything from you. This is what I’ll tell you. I’ll give you deep in liquid markets. I won’t take up your time and then I’ll give you good fills. And I did that. And I traded with him for Theo for like a year. And you know, it was a very grudging relationship. He did not want to build it cause you already had relationships, but it’s kind of like a drug dealer analogy. Right? Do you want to be able to sell, you know, small quantities of drugs to a thousand people or do you want to sell a gigantic pile of drugs to one guy, one time for a good price? Just a lot easier. Everybody is inherently lazy. Everybody wants to do the least amount of work for the most amount of money. And if you can convince somebody that you will make their life easier and more profitable, you can do business.

Jason Buck:

No that’s, that was perfect too. It’s not even like, because I know this exact experience is like not, you know, second or third tier, you know, prime brokers and they’re not the second or third year, but like that’s where you start because they’re willing to take on a smaller business because they’re not Goldman. And then you start finding out how everything works that way. And then you start asking the people that work with Goldman for any sort of referrals or anything like that. And then Goldman, almost like you just said earlier with the initial traders, like anybody that’s willing to work hard and show they’re willing to pull in the effort every day, then you’re going to try to help them. Right. And so if you start a smaller fund at like a, let’s call it a second tier, even though those are not tiers, like prime, then you’ve shown you built a fund, right? So then when you go to talk to Goldman, you’re like, look, here’s my fund. Here’s my track record. I’m not just asking you for hope and a dream. Here’s tangible evidence that I know how to build a firm. And then the door’s open where all of a sudden that the notional a 100 million can come down to maybe 25 to 50 because you’ve, you’ve proven that you’re somebody that’s going to go out and be an earner.

Noel Smith:

Yes. And, you won’t embarrass them by being outside of compliance or whatever else. You’re not going to want to follow the regulators. You’re going to be a play within the paint guy. They want, they want to know that, too. They don’t want to get in trouble because of you, they don’t want you…Your presence to add to their worry list. You want to make their life easy, not hard.

Darrin Johnson:

Do you…I would think that you would want at least two primes, right? Like just because in the event that a Lehman happens or like I had a buddy who started a small CTA, he started with, it was about 10 million and he just had horrible luck and MF Global happens and he ended up getting 80 cents on the dollar of his, of his SMA money and pulled money back.

Noel Smith:

That’s pretty good.

Darrin Johnson:

But that was three years later.

Noel Smith:

Yeah.

Jason Buck:

Right.

Darrin Johnson:

And he never really recovered from it. I mean, he got most, he was able to get back into like the high seven figures, but he was never able to build into a Chesapeake or Dunn or any of the other big names. He is a young guy. I mean, he’s our age, you know, and…But that was devastating to him, and it was just bad luck and he didn’t do anything wrong. His compliance, his audits, everything was on point. It was just really horrible, horrible luck. And so like, how do you deal with that as a problem or even Jason, in your case, like a fund up.

Noel Smith:

That, that’s just a hard, cool fact of life, man. Sometimes it’s just luck. Some people are lucky. Some people just slip on a banana peel and fall. I don’t know anybody that knew MF Global was going to happen. I had an account with Bear. I had an account with Lehman. We got out. But you know, if I, my account at Goldman goes to zero tomorrow. I don’t want to tell you other than man, I don’t know what to say. I mean, these…You are the last person they’re going to tell. So unless you hear it through the grapevine, they’re not going to tell the people that have money in their, you know, vault. It’s just not going to happen. So they’re going to do everything they can to hide that information. I had an account at a, a future’s account, at this firm and I didn’t find out until a year after the fact that they were pretty close to blowing out after Volmageddon in 2018. I didn’t know that, but they never told me, I found out through completely circuitous routes.

Jason Buck:

Right. Darren, to answer your question, like the way I think about it is it kind of makes it a pain in the ass, but you have to worry about these things especially if you think about the world in a long Vol sense it’s like, you know, we have multiple FCM’s, kind of multiple primes in a way that kind of do give’s up’s between each other. So you’re trying to diversify that way. I’m also kind of, even though I prefer the liquidity of SMAs on exchange and diversifying my FCM’s that way, I still will take a few funds off those centralized exchange that are maybe like clearing a Goldman or whoever else too, because like it’s adding more diversification there. And then you have to think about with your actual bank where you keep most of the cash, you know, are you buying T-bills, you know, where’s your segregated gold, you need to like constantly….Like, but Darren you’ve been an entrepreneurial your whole life, too.

Jason Buck:

This is all entrepreneurial risk, right? You’re always worried about somebody’s going to screw you in some way. So you’re like, and so Noel almost has a point. It’s like, there’s a bit of luck to it. I mean, you try to diversify your diversifiers. You try to hedge as much risk as possible. But you know, there is some luck, there’s some luck involved and you know, a lot of times like you’re, you’re friended, you can recoup the money, but it might be locked up for two to three years. And time is just as valuable as money, and that’s the really hard part sometimes. And then what happens is the exchanges will tell you and the FCM’s like, we changed a lot since MF global and it’s like, yeah, you did, because they figured out how to screw you. But the next person that’s going to screw you is not going to do it the same way as MF Global did.

Noel Smith:

Right.

Jason Buck:

And so like, that’s the risk like…It’s always…They’re fighting the last battle, and so you have to like, think about, yeah, like how do you diversify across FCM’s, across exchanges, across banks across, you know, all your different service providers. And it creates all these like kind of, you know, this rats nest of redundancy, that’s kind of like annoying, but like if you want to, you know, try to be as robust as you can, you know, that’s part of the situation, I guess.

Noel Smith:

Ultimately you don’t know. I was talking earlier today about Enron. I mean, Enron was audited by a big six firm. They were the ninth largest market cap in the country. They went to zero, you know, who knew? I mean like five guys knew, right? Everyone else is like, maybe, I don’t know, but I’m not trying to say don’t do your homework, but I’m just saying like, you know, you could spend a full time job just doing homework and not even focus on the 99,000 other things you have to do. All you can do is what Jason said, diversify it and you know, try to get the best information you can. But ultimately if people want to lie to you, they’re going to lie.

Jason Buck:

Yeah. It’s usually people like falsifying brokerage statements. I mean just outright fraud. That’s like stuff that’s really hard to even catch, that’s just insane that I’ve seen numerous cases of and I’m sure Nole has seen it, as well.

Jason Buck:

Part of it, I was wondering like, Nole, like I was just thinking out loud to myself, or in my, the voices in my head, besides even starting a prop shop, have you ever seen almost…And I’m sure you have is like almost a bunch of individual prop traders almost getting together so they could create a little superhero group where they’re able to cross margin at maybe the prime and then they’re able to diversify. So if like I’m somebody that’s trading one very specific like option strategy on SPX and I kind of know where my weak points are, does it behoove me to try to find four or five other guys or girls that are trading, you know, uncorrelated strategies to mes o I can actually diversify my own personal P and L risk, you know, as I’m trying to, you know, eat what I kill.

Noel Smith:

I mean, if you want to be the Traveling Wilbury’s of, you know, finance then sure. So totally yes is the answer, but realistically you probably don’t know a rockstar in gold, a rockstar in bonds, a rockstar in corn, a rockstar in, you know, mortgages and CDS. Just the idea that you would know all these people and they would all be off their non-competes and they’re all wanting to quit their multi-seven figure jobs at the same time. It’s tough to assemble that, you know, unless you are literally like a Ken Griffin type where you can just start anew, if you really wanted to. It’s really tough to do. Realistically, most prop firms that I know of that have been started, you know, are just two dudes that are buddies that also have some money and they figure it out and they both trade probably mostly the same thing or somewhat the same thing, and then you figure it out. That’s more realistic.

Darrin Johnson:

Yeah. Also Jason, like, I was just think…I was thinking with your question, right, like most profitable traders, like Nole was describing know guys who trade similarly to them. Right? So like if you’re a ball guy and you’re in equities and you deal with small caps, you tend to know people who tend to trade around that same edge, right? Like that’s who you tend to fraternize with and hang out with and talk to whether, even if it’s virtually, knowing somebody all the way on the other end of the spectrum, who let’s say is a rockstar and Nat Gas or whatever, like, that’s that actually, that’s probably not that common.

Noel Smith:

It’s not, it’s very rare actually. And it’s funny how, how many people, I know that only know guys that are Nat Gas guys or only know guys that are whatever guys, that’s very normal. So, you know, you’re on a desk with a handful of other people, you guys all gossip about the same stories about whatever, but the chance of you knowing about somebody that’s in CDS and that’s all they do, unless you have a reason to know them, you probably don’t.

Jason Buck:

Yeah. Part of it’s like, I always had a problem when like reading market wizards, like all these trend followers and everything that have these divergent strategies, and you’re like, where do you guys get hurt? Oh, in mean reversion or conversion strategies. I’m like, well, go make friends with a, with a mean reversion trader, and then you have a better P and L, but like, nobody wants to do that like you guys are saying, but like maybe, no thinking out loud is like, is maybe the way to do that is almost start like an exempt CPO of less than like 15 participants and then that’s how you can find the other traders and allocate capital to them to diversify your P and L.

Noel Smith:

If you’re doing a CPO, then you also have money and other stuff. So you have to comply within those percentages, as well. So, that I think would be, you know, cumbersome just from a compliance standpoint, I think it would be simpler to just, you know, you assemble a small team of people, assuming you have some level of capital, and what you do is you do your best to make a P and L, you have it verified to any preponderance of a doubt because anybody who…If you come to me and you say, Hey, I want…I’m a Nat gas trader and I want you to give me money. I will hammer you on your P and L there’s I…The bar to convince me that you’re going to make me money is high, but I’m convincable, you know? And I got to believe everybody, every other firm would be the same way. I mean, if you just figured out how to convince me, then we can probably do some business, but you’re going to have to super duper show with, you know, everything and everything. You got to take your pants down and let’s say, ah, because that’s how it’s going to have to be.

Jason Buck:

Well, let’s start with the, like, who would you even respect as auditors?

Darrin Johnson:

How long does the track record need to be for you?

Jason Buck:

Well, that’s a good question. Yeah.

Noel Smith:

Depends. So it’ll depend on the environment. So, you know, stocks are down right now, right, but they’ve been up for a long time. So, how do you trade Vol in 2022 versus how do you trade Vol in 2017? They might as well be Nat Gas and gold because they’re totally different. So if you want to demonstrate mastery of a marketplace, you have to have some time. If you just like, yeah, I’ve been selling putts and it’s 2017, I’m up 27%. All I do is sell putts. Well, that’s easy, because all the market has done nothing. Right. And your putts have died every day and you’re a hero, but then we go into 2018. Now you’re dead 50 times over. So I don’t know, are you a good trader or you lucky trader that’s the job on my end to figure out if you are a good trader or you’re just lucky for a little while,

Jason Buck:

Then obviously it matters like frequency of trades and everything too, for you to get more statistical significance. And…

Noel Smith:

Yes.

Jason Buck:

But what I was asking, too, is like what…Who would you respect to run the audited track record? Like if somebody wanted to bring you a track record, who should they think about getting it audited by that you would then say, oh, this is at least semi-legit. And then that keeps the conversation open.

Noel Smith:

You know, I used my, my first real accounting firm was Grant Thornton and they were very on above board. They were totally fine. It’s got to be somebody that’s Googleable. It can’t be the, you know, the CPA down the street. You’ve got to spend probably no less than five grand in an audit. I mean, an audit from a big six firm is going to be, you know, 30, 40 grand on the very light side. But, if you’re not spending at least five grand for an audit, I just can’t imagine the results are going to be taken seriously.

Jason Buck:

I mean, as you can’t be Bernie Madoff using somebody in upstate New York in a single family office.

Noel Smi

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