Yes, everyone hates bankers now, and politicians threaten to destroy private equity…

…but plenty of people still fantasize about becoming Portfolio Managers and earning hundreds of millions of dollars.

At that level, who cares if everyone hates you?

The only problem is that the reality is much different from the headlines about hedge funds or what you see on shows like Billions:

What Does a Portfolio Manager Do?

The Portfolio Manager sits at or near the top of the hedge-fund hierarchy.

At single-manager funds (SM funds), the PM started or took over the fund and has responsibility for everything that happens.

At multi-manager funds (MM funds), there are potentially dozens of PMs who are each assigned a certain amount of assets under management (AUM) to invest.

Regardless of the fund type, the PM makes final trading decisions, manages risk and the entire portfolio, and oversees back/middle office operations such as compliance, IT, and accounting.

The PM also reviews ideas generated by junior team members and is responsible for marketing the fund, raising capital, and maintaining relations with the Limited Partners.

The Portfolio Manager earns money based on his/her performance (Profit & Loss Statement – P&L or “PnL”) in the year, which means that it’s possible to earn a bonus of $0, or a bonus in the millions of dollars… or anything in between.

On average, PMs tend to earn far more than Hedge Fund Analysts because making the correct trading decisions, executing them, and managing risk are more valuable skills than generating investment ideas.

Many smart people who know accounting and finance (or coding/statistics/math on the quant side) could come up with ideas and hedge fund strategies that have the potential to make money.

Without the hedge fund portfolio manager, however, those ideas and strategies would remain in the “potential” column – not the “actual dollars realized” column.

Research Analyst vs. Portfolio Manager

There are some similarities between the different roles in the hedge fund career path; for example, everyone generates and evaluates trading ideas, monitors current positions, and conducts due diligence.

But the key difference is that PMs are responsible for far more than those tasks:

1. Investment Logistics – For example, what percentage of AUM should you allocate to Idea X vs. Idea Y? What’s the best way to hedge, and how much should you allocate to that? How well can the traders execute the orders required to build the position?
2. Risk Management – PMs focus on risks related to both the individual positions and macro factors that might affect the entire portfolio – and how to prevent disaster if there’s a market meltdown.
3. Entire Portfolio – PMs spend more time thinking about portfolio-wide diversification and points like the net exposure (% long positions – % short positions). Even if Company X has 50-70% upside, it might not make sense as a Long if it doesn’t fit with the rest of the portfolio, or if it would skew risk too much in one direction.
4. Non-Investment Responsibilities – PMs must spend time marketing the fund, raising capital from LPs, and answering their questions and concerns. They also oversee the infrastructure required to support the fund, which means they may be further removed from the nitty-gritty details of investing.

Some of these points change a bit for hedge fund portfolio managers at multi-manager (MM) funds; for example, such funds will probably have separate teams for IT and other middle/back-office functions.

Also, since most MM funds run tight net exposure, there’s less flexibility with the structure of the entire portfolio and risk management.

A Day in the Life

This one will vary based on factors such as the fund type, strategy, and AUM, but if we use the same type of fund as in the Analyst article:

• Fund Type: Single Manager
• AUM: $1 – $5 billion range
• Strategy: Long/short equity or other long-term, value-oriented strategy

Then your typical day as a PM might look like this:

6 AM – 7 AM: Wake up, check your phone before rolling out of bed, and see what happened in Europe and Asia overnight and how it will affect your positions.

You get ready and head into the office while listening to a few finance/market podcasts.

7 AM – 9 AM: Arrive at the office, read news related to your current holdings as the rest of the team arrives, and take notes on issues to follow up on throughout the day.

An existing LP also “wants to chat” sometime today.

Your team takes turns pitching ideas, and you hear a few interesting ones about over-levered REITs with high retail exposure that could be good Shorts.

9 AM – 10 AM: Just before the market opens, one of your companies (a building door manufacturer) announces a plan to spin off its EMEA division.

You immediately call the Analyst who worked on that idea and ask him to run the numbers, and the company’s stock price opens down 5% in the first 30 minutes of trading.

To hedge against the risk of an even bigger drop, you think about asking the traders to increase your stake in an industrial conglomerate that is a potential buyer of this division.

10 AM – 11 AM: The Analyst runs into your office with the quick numbers.

The expected selling price for this division is a ~20% discount to fair value, which is why the market hates the deal.

But it doesn’t contribute enough to the company’s financials to justify a 5% drop, so you ask the traders to up your stake – easy to do when everyone else is selling.

11 AM – 12 PM: The LP from earlier in the day finally gets through to you (you were dodging his calls up until now).

He’s skeptical of your current portfolio because he thinks you’re mostly holding small-cap stocks, even though you have a mid-cap focus. You agree to send him more information later.

12 PM – 1 PM: You meet with a Sector Head and another Analyst and find out that you’re in trouble with another position, a 4-5% stake in a software company.

The CEO has just announced an aggressive, high-growth-at-all-costs strategy. You and the Sector Head want to sell your stake immediately, but the Analyst pushes for a longer-term hold.

1 PM – 3 PM: You review the best ideas from your team over the past week and think about how to structure potential new positions.

You want to maintain a net exposure of 40% (e.g., 70% long and 30% short) while limiting each sector to 15% of your total AUM.

One new Long idea is in Healthcare, where you already have 10% of AUM, so you decide to allocate 5% to it and then sell off a 3% stake in another Healthcare company to stay under 15% total.

3 PM – 4 PM: You conduct a quick job interview with a Senior Analyst candidate from a larger fund. You like her ideas, so you ask the other Senior Analysts to speak with her as well.

Then, you get interrupted by a new potential investor calling to request performance stats.

4 PM – 6 PM: The markets close, and neither the software company nor the door manufacturer has turned into a disaster… yet.

You finally get time to do uninterrupted research on an idea one of your Analysts brought you last week.

6 PM – 7 PM: But then news breaks that executives at that software company are “staging a coup” to remove the CEO. The Analyst and Sector Head come into your office, and you all agree to sell your stake ASAP to cut your losses.

7 PM – 9 PM: Go to dinner with a few brokers and other hedge fund portfolio managers. The brokers keep pitching ideas that you’re not interested in, but you stick around to get a sense of everyone else’s mood.

They all seem downbeat, so you avoid mentioning that your fund is up 15% YTD.

9 PM – 10 PM: Head home, respond to a few personal emails, and go to sleep.

Hours and Lifestyle

You could argue that professionals at hedge funds “work less” than ones in investment banking, but this day-in-the-life account shows the flaw with that argument: the stress levels and intensity can be much higher.

Many PMs work around 60 hours per week (or more), but they’re “on call” all the time because the markets are always moving, and potential crises are always waiting.

At multi-manager funds, the PM may not be quite as responsible for non-investing tasks, but stress comes from lower risk tolerance – if you have a bad year, that might be the end for you.

Hedge Fund Portfolio Manager Salary (and Bonus) Levels: Where the Fun Begins

So, the PM job is quite stressful, and you need a wide variety of skills to succeed… but the huge compensation makes up for it, right?

Well… maybe.

Compensation spans a huge range at this level because it’s linked almost 100% to performance.

We gave a range of $500K to $3 million USD in the hedge fund career path article for the “average” PM, with median pay in the high-six-figure-to-low-seven-figure range.

But there are several important footnotes and caveats.

First, there are thousands of small/startup funds (< $50 million AUM) that are not necessarily included in these compensation surveys.

Pay tends to be far lower at these funds because the average AUM is much lower.

These compensation figures are most applicable for funds with $250+ million under management.

Second, base salaries are often capped at less than $200K because no hedge fund wants to pay much more until

Third, total team compensation is between 10% and 20% of their P&L, depending on the fund size, structure, and the team’s split of the total AUM.

Here’s an example to illustrate the math:

Let’s say that you’re managing a $500 million portfolio at a multi-manager platform fund with $20 billion total in AUM.

The fund had mediocre results for the year, but your team had a positive performance, so you’ll get paid.

Your team earns a 3% return on its $500 million for the year, for a P&L of $15 million.

Yes, a 3% return may seem low, but most MM funds are highly levered because of their neutral net exposure… so 3% could add up to far more at the platform level.

For example, many of the large MM funds, such as Citadel, run 0% net exposure but 400-500% gross exposure (gross exposure = long % + short %).

In addition to your annual profits of $15 million, your team also had expenses in the form of administrative staff, data providers, Bloomberg terminals and other IT, travel and meals, and so on.

Altogether, those add up to $1 million per year.

So, the “Net P&L” before bonuses is $14 million.

Your team earns 15% of that, which is $2.1 million.

You have one Analyst and one Senior Analyst, and you allocate bonuses and base salaries such that the Analyst earns $300K and the Senior Analyst earns $600K.

That leaves $1.2 million for you in total compensation.

Of this $1.2 million, you’ll receive $150K – $200K during the year in base salary, and the remaining $1 million or $1.05 million as a bonus at the end of the year.

How to Become a Hedge Fund Portfolio Manager

No one ever “becomes” a Portfolio Manager from outside the finance industry; you need a track record and years of experience managing money first.

The four most common paths to PM include:

1. Perform well over 5-10+ years and get promoted internally (possible at MM funds; less likely at many SM funds).
2. Switch jobs and move to a smaller/startup fund or one that is expanding and willing to take a chance on promoting you.
3. Join a MM fund that has clear promotion opportunities and is willing to bring you on as a Junior PM.
4. Start your own hedge fund.

Paths #1 and #2 are probably the most realistic ones if you develop a solid track record.

And we’ve covered all the reasons why it’s probably a bad idea to start a hedge fund before, but knock yourself out if you enjoy the pain.

The key to everything above is performance.

If you cannot point to a consistent track record of generating a P&L within teams and funds that have done well, you will not become a PM.

Is a Hedge Fund PM Role in Your Future?

For most people, a PM role is probably not appropriate.

This point is part of a broader one about the hedge fund vs. private equity vs. investment banking debate.

In IB and PE, you can succeed by following a process and advancing up a clearly defined hierarchy.

You don’t necessarily need to be “passionate” about deals as long as you can execute them, stay on top of process details, and avoid mistakes.

But with hedge funds, you must be passionate about the markets and investing to get into the industry, and you can’t “fake it.”

And you can’t just “follow a process” to reach the PM level – you also need performance results every single year, and there isn’t one universal method for achieving that.

Plus, you must also be able to make time for all the other tasks besides generating and evaluating ideas.

Managing a personal or family portfolio is no guarantee that you’ll be able to do the job because trade execution and risk management are totally different at the institutional level.

If you understand all that, then the job might be up your alley.

And if not, you can always fantasize about it by watching Billions.

The post The Hedge Fund Portfolio Manager Job: A Day in the Life, Salaries, and Trade-Offs appeared first on Mergers & Inquisitions.

Numi Advisory has deep expertise in Equity Research careers, having advised over 600 clients by providing career coaching, mock interviews, and resume reviews for people seeking jobs in equity research, private equity, investment management, and hedge funds (full bio at the bottom of this article).

So, you won equity research interviews by networking aggressively…

You presented 2-3 well-researched stock pitches and passed your interviews…

…and despite MiFID II and rumors of the industry’s demise, research teams still exist at banks.

What happens when you start your equity research career, how much will you work, and what exit options will you get?

All good questions – so we’ll answer all of those and more here:

What To Expect In An Equity Research Job

Similar to other public-markets roles, you might arrive at work a couple hours before the market opens. In New York, that means “around 8:00 AM.”

Once you arrive at your desk, you’ll spend some time catching up on emails from traders and salespeople, reading the news, and monitoring overnight market developments.

The rest of the day is a mix of keeping things up to date (e.g., financial models), researching companies, and finding new companies to initiate coverage on.

The best and most experienced Associates also interact with clients and set up management meetings between companies and buy-side firms, and these are the real moneymakers for equity research careers in the post-MiFID II environment.

Doing the work required to initiate coverage and building the initial model can take months, so teams need to balance that with other tasks, such as client summits and conferences.

Professionals in equity research careers are best-known for insightful reports, but these reports do not necessarily take up the bulk of staff time.

That said, if the group is working on a detailed “thought piece” that reaches counter-consensus conclusions, that can consume a lot of time and effort. But it can also be worth it if it results in more viewership and client interactions.

Your time allocation during the day depends heavily on the industry you’re covering and how the Research Analyst (read: your boss) likes to run things.

In some teams, Associates spend 75% of their time modeling, but in others, it might be closer to 25% – and that percentage often changes over time.

Often, junior team members get tasked with modeling or grunt work, especially in larger teams, and senior members spend more time talking to investors and companies.

In equity research internships, you’ll assist the full-timers with data gathering, industry research, model updates, and more.

Equity Research Hours

If it’s a normal day, you might leave around 8:00 PM, which means ~12-hour workdays.

However, hours get significantly worse during earnings season, which happens once per quarter, and during industry conferences.

Unforeseen news events and developments, such as regulatory changes, M&A deals, earnings pre-announcements, or Amazon entering your space, can also make the hours worse.

Earnings season is busy because you have to update all your models and issue new reports with new estimates, and industry conferences are busy periods because you run around meeting people during the day and then do your actual work at night.

In both those periods, the 12-hour days can easily turn into 16-hour+ days, so the job will approach investment banking hours.

If you experience consistent mid-intensity stress levels in banking, equity research careers give you low-intensity stress most of the time, with occasional spikes to high stress.

As with any other public-markets roles, your schedule can be tough if your time zone doesn’t match the time zone of the major financial center in your region.

For example, if you’re on the West Coast of the U.S., you can look forward to waking up at 4 AM and arriving at the office by 5 AM each day.

Finally, the hours can get worse as you advance because Analysts have to travel and interact with clients while still assuming responsibility for published research.

Equity Research Careers: Example Reports and Other Deliverables

The published reports represent the “deliverables” that most people associate with equity research.

We linked to a few examples in Part 1 of this series on equity research recruiting:

• Morgan Stanley – Update on Lululemon Athletica
• Morgan Stanley – Initiating Coverage on Citizens Financial Group
• RBC – Initiating Coverage on Waddell & Reed Financial
• Lehman Brothers – REIT Sector Overview
• Lehman Brothers – Initiating Coverage on CBS Corp

You can divide these reports into three broad categories:

• Initial Opinion / Initiation of Coverage (IOC): This one is the first report ever published by the team on a specific company. It tends to be long (dozens of pages or more), and it has a lot of industry/market data, detailed rationale for the projections, information on competitors, the company’s valuation, and more.
• Industry Overview / Primer: This type of report also tends to be long (dozens of pages) because it covers an entire industry, such as U.S.-based pharmaceutical companies or European ground transportation companies (read: trucking). There will be sections on trends and key drivers/metrics, risk factors, legislation, and overall valuation levels, followed by shorter sections on specific companies.
• Company Note: This report is shorter (5-10 pages) and is issued when a company reports earnings, hosts an investor day, presents at a conference, or makes an announcement that impacts its strategy, such as an acquisition or the launch of a key product.

The “Initiation of Coverage” and “Industry Overview” reports consume a lot of resources, so teams must weigh the benefits carefully before deciding to invest the time and effort in creating them.

A typical research team covers around a dozen companies, so if your sector is “Large-Cap European Airlines,” your coverage list might include the Lufthansa Group, Ryanair, IAG (British Airways, Iberia, and others), Air France-KLM, EasyJet, Turkish Airlines, Aeroflot Group, Norwegian Air, Wizz Air, Pegasus, Alitalia, and TAP Air Portugal.

You focus on names that buy-side investors are interested in – in Europe, they’re paying you directly for the research, and in other regions, they’re making trades through your bank and generating commissions, and you encourage those trades with research.

Some boutique and middle-market firms focus on lesser-known names because they can add more value when they’re not team #37 covering the same company.

Your team might decide to initiate coverage on a new company when a firm you cover is acquired or gets de-listed, or because the company’s strategy or business model changes, or because your team gets additional headcount.

When that happens, you can expect to do a deep dive on that single company and its sub-industry for weeks or months until you have a detailed projection model and qualitative research to back up your assumptions.

The Equity Research Hierarchy and Promotions

In research, the most senior team member is the “Analyst,” and below that are the “Research Associates.”

Each team usually has one Analyst and 2-3 Associates, with one Associate for every 7-10 names under coverage.

This system is a bit confusing because “Analyst” and “Associate” are just the titles used on published reports.

Internally, the hierarchy is still similar to the one in the investment banking career path, where you advance from Associate to VP to Senior VP/Director to MD.

The difference is that Analysts can be different levels: VP-level Analysts vs. MD-level Analysts, for example.

The total headcount across equity research at all banks in the U.S. is an order of magnitude smaller than the investment banking headcount: Hundreds of professionals rather than thousands.

That smaller industry size and the historically lower turnover mean that it’s often difficult to advance in equity research careers by staying at the same bank.

Sometimes you may get lucky and find an opportunity if your Analyst suddenly leaves, but you’re more likely to get promoted by joining a different bank.

To advance, you must build a reputation instead of burying yourself in Excel all day. No one cares how fancy your model is – they care how good your insights are.

Many Associates struggle to move up because they don’t take the time to get to know management teams and institutional investors.

If you don’t perform well enough to advance, you won’t necessarily be fired dramatically; research professionals are cheaper than bankers, and there’s no fixed 2-year or 3-year program.

That said, it is not unheard of for entire research verticals to be eliminated during cost-cutting season.

At the junior level, people tend to stick around for 2-4 years before moving to another firm or leaving their equity research careers behind.

Equity Research Salary and Bonus Levels

As of 2018, Associates in major financial centers tend to earn between $125K and $200K USD in total compensation, with about 75% of that from their base salaries.

Post-MBA and graduate-level hires earn in the middle-to-high-end of that range, and possibly slightly above it.

As with investment banking compensation, you’ll probably earn below this range in London for a variety of reasons (GBP/USD, Brexit, MiFID II, pay is almost always lower in Europe, etc.).

VP-level professionals earn between $200K and $300K, again with 75%+ from their base salaries.

However, at smaller banks, VPs could earn below this range – something closer to the Associate compensation range is possible at the lower end.

Directors might earn between $300K and $600K, with 50-75%+ of that in base salary. At this level, the year-end bonus starts to make a huge impact on total compensation.

Finally, MDs could earn between $500K and $1 million, with base salaries in the $250K – $600K range.

Back in the dot-com boom of the late 1990s, some Analysts earned $10 million+, but these days, it’s a great outcome if an MD-level Analyst clears $1 million.

To earn in the low millions (say, $1.0 – $2.5 million), you’d likely have to be one of the top few Institutional Investor-ranked Analysts.

With MiFID II, these numbers will almost certainly fall – especially in Europe.

Equity research careers have always paid less than ones in investment banking, and that difference is likely to widen over time.

Historically, bonuses were based on 1) Analyst rankings such as the Institutional Investor Poll (II) Greenwich Poll; 2) the performance of Buy/Hold/Sell calls; and 3) revenue indirectly generated via trading commissions and investment banking fees (e.g. from companies going public or public companies issuing follow-on offerings through the bank).

With MiFID II, the basis of compensation will presumably shift to the amounts buy-side firms are spending directly on research.

The research reports themselves are not necessarily that expensive, but interactions and management meetings, non-deal roadshows, and conferences add up, and in some cases, buy-side firms end up spending more and consuming less.

Buy-side firms spend this money because many of their professionals cover breadth rather than depth, and sell-side Analysts might know specific companies in more detail.

Research compensation is likely to become more lopsided, with the top-ranked groups garnering the bulk of the fees and lower-ranked firms fighting over the scraps.

Equity Research Exit Opportunities

The bad news is that it is almost impossible to break into private equity directly from equity research.

Yes, a few people have done it over the years, but it’s far easier to transfer into investment banking first if you want to go that route.

You do not work on mergers, acquisitions, or leveraged buyouts in equity research, which makes your skill set not-so-useful for PE roles.

It’s far more common to move to hedge funds or asset management firms since there’s a direct skill set overlap – you analyze public securities and make investment recommendations in each one.

Within that category, long/short equity funds are the most natural fit for equity research professionals, while global macro funds are the worst fit because you work on the “micro” level in most equity research groups.

Other types, such as merger arbitrage and event-driven funds, could be a good fit depending on the sector you covered and the importance of deals, news, and events in that sector.

For more about this topic, please see our articles on hedge fund careers and private equity vs hedge funds.

Another option is to start your own fund eventually, which we cover in our “How to Start a Hedge Fund” article – but the key word there is “eventually” since you won’t be able to do this directly out of an ER role.

You could also move into the corporate finance career path at normal companies, investor relations, or potentially even corporate development – your industry expertise may compensate for less deal knowledge there.

Some professionals also leave their equity research careers and move into corporate strategy because their coverage and analysis of companies is typically higher-level, which fits right in with strategy.

In those roles, you might also be in charge of competitive intelligence, monitoring your firm’s peer group, and publishing internal reports.

Some research professionals also decide to attend business school, and if they do, they’re viewed similarly to other high-performing financial professionals.

One challenge is that it can be harder to get solid recommendations in equity research because team sizes are smaller, and the Analyst calls all the shots.

So, if your Analyst relationship isn’t great, you may have to request recommendations from other groups or people outside the firm.

It’s not uncommon to ask another Associate, a salesperson, or a trader for a recommendation for this reason.

Are Equity Research Careers Still Worthwhile?

Going back to that question we posed in Part 1, our most frequent query about equity research careers goes something like this:

“Everyone says the industry is dying! Should I still go into it? Won’t the new regulations, falling commissions, and passive investing destroy everything?”

And the answer remains the same: The industry won’t go away overnight, but it is less appealing than it once was.

However, that matters a lot more for Senior Analysts with 10+ years of experience whose business models are being pulled out from under them.

If you’re at the undergrad or MBA level, you could still make a solid case for working in equity research for a few years and then using the skill set to move into another industry.

You’ll do more interesting work than in investment banking.

You’ll have more of a life, with saner, more predictable hours and occasional stressful periods.

You’ll build a solid network of buy-side professionals and company managers.

And you might even be able to sneak in through the side door – like an undervalued stock.

• Equity Research Recruiting – Part 1
• Equity Research Careers – Part 2

Want more?

You might be interested in Biotech Equity Research: The Best Escape Plan from Medicine or Academia?  or The Equity Research Analyst Career Path: The Best Escape from a Ph.D. Program, or a Pathway into the Abyss?

–

Numi Advisory has provided career coaching, mock interviews, and resume reviews to over 600 clients seeking careers in equity research, private equity, investment management, and hedge funds. With extensive firsthand experience in these fields, Numi offers unparalleled insights on how to ace your interviews and excel on the job.

Numi customizes solutions to each client’s unique background and career aspirations and helps them find the path of least resistance toward securing their dream careers. He has helped place over 150 candidates in leading buy-side and sell-side jobs. For more information on career services and client testimonials, please contact numi.advisory@gmail.com, or visit Numi’s LinkedIn page.

The post Equity Research Careers: A Day in the Life, Advancement, Compensation, and Exit Opportunities appeared first on Mergers & Inquisitions.

This is a guest post from “DerivsTrading,” an experienced options trader who has worked at both bulge-bracket banks and hedge funds in London. He defied the odds and broke into sales & trading coming from a non-target school.

We’ve covered a few days and 48-hour periods in the lives of sales & trading interns before, but what about when you start working full-time?

Even if the hours and stress levels are still brutal, do you at least get to do more “real work”?

Or are you stuck picking up lunch for everyone on your desk?

Let’s jump into this day-in-the-life account and see exactly what you do as a full-time options trader at a bulge bracket bank – and hey, you might even improve your knowledge of the Greek language in the process…

Early Risings

5:45 AM: Wake up. No matter which desk you end up on, you are most likely going to be waking up around this time.

Adjust your sleeping habits accordingly or suffer for most of the day. Also keep in mind that even if you go out the night before, you are still expected to be in on time and alert. Any signs that you are at less than 100% capacity will be looked upon very badly.

6:30 AM: Arrive on the desk. The market opens in 90 minutes, so it’s really a countdown from here. 20 minutes is spent just turning on all the systems; with 4 computers and each one running 10-15 different applications, this is quite time-consuming.

Inevitably, you’ll forget to log into at least one crucial system each day and then realize it at the absolute worst moment.

6:50 AM: Start reading various new sources – generally FT, Bloomberg, City AM, and then the internal research that comes out. Finish off with a couple broker chats.

You need to know, before the open, any market information that can affect your stocks – how it might affect your P&L and what the Cash Equities Traders are calling it that day (most cash traders after a big piece of news will call a stock up or down x%).

7:15 AM: Look at the largest positions on the book and try to come up with a rough game plan for the day. I generally like to make a list of risks I don’t like, in order of priority, and then work down the list throughout the day.

You want to make sure you know the biggest risks in every category (e.g. gamma, vega, delta, decay, skew, div).

NOTE FOR NON-TRADERS: These metrics all measure characteristics of options; for example, delta is the rate of change of the option value relative to the changes in the underlying asset’s price (basically the first derivative with respect to price).

Vega is the first derivative of the option’s value with respect to the underlying asset’s volatility; gamma is the second derivative of the option’s value with respect to underlying asset price (so the first derivative of delta).

Unlike in investment banking, you actually need to know (some) math here.

In a large options book there is also a lot of “hidden risk.”

Therefore, you can’t just look at your overall risk for a name – you need to know where your largest strikes are, and how your risk changes through spot and time.

For example, you might see yourself long gamma, but actually you might be short a strike that expires in 2 weeks that is 10% away.

You need to know about all of that because if the stock makes a big move, that strike will start kicking out a very large short gamma (this is also why most traders are unwilling to sell short dated OTM options).

Morning Meetings: The Worst Time to Show Up with a Hangover?

7:30 AM: Morning meeting with sales and research, which is generally the worst moment of your entire day if you have had a rough night out. The macro summary is given, and then everyone discusses important research updates.

7:50 AM: Take one final glance over the stock news to make sure you haven’t missed anything just before the open (which is at 8 AM in London and a few other regions).

You never want your boss to ask you a question that you don’t have an answer to: if you’re running risk, you need to be aware of everything at all times.

8:00 AM: The market opens. You watch any big movers, see that cash equity prices find their levels fairly quickly but volatility (vol) levels adjust a bit more slowly; generally, within the first 10 minutes you get an idea of where vol is on most names.

If there are earnings or big announcements, you will generally not quote until the screens come in a bit. For the first 10 minutes, the vol spread will be extremely wide and you can easily get picked off.

8:15 AM: First wave of client requests comes in. If you cover several sectors, you can get a backlog of 7-10 prices pretty quickly.

You prioritize all these requests by client and size; even when you only have a couple minutes for each price, you need to make sure you have all your bases covered.

Options trading is very tricky because there are so many different risks – you need to make sure you’re not being picked off on vol (check if anything similar in the broker market is already trading to hedge your risk and skew pricing accordingly), make sure you’re not being picked off on divs, and make sure that you can find borrow on the stock if you’re selling shares as part of the trade.

If the government steps in and restricts short-selling for some reason, this last risk can become more of an issue.

US vs. European Options

8:30 AM: Finally send off last of the prices, get some time to look at how the book is doing, and start phoning up brokers and start working some trades.

Options on single stocks in Europe trade a bit differently than in the US because the liquidity is not the same – the issue is that screen prices are kept very tight in extremely small sizes, and clients expect the same spreads in sizes that are 50x larger.

But the problem is that unless you can find someone to find the other side in the broker market, you will get wider prices with brokers than you give to your clients.

This means that to survive, you constantly need to be aware of what brokers are working so that you can spot chances to offload risk.

That way, when a client request comes in you can skew it appropriately. The best case scenario: when you know someone is a buyer in the broker market, you can buy it from a client at a vol from mids, and then offload it in the broker market at a vol above.

However, this is very rare, so most of the time you need to make a price based on a prop view (if you will). You need to price it according to your view of the trade, instead of where you can offload it.

9:15 AM: Things start calming down around this time, and you might chat with co-workers or use the time to go for a bathroom break.

Always go when you have a chance and not when you need to – nothing distracts you more than having to go to the bathroom when you’re in the middle of something.

10:00 AM: It’s still fairly quiet, so you finally get to fire up Excel and work on some longer-term projects. It gets difficult on a flow book because you need to find the balance between looking after the risk, but at the same time also exploring opportunities to move the business forward.

It’s sort of like the dilemma mid-level bankers face in executing deals vs. sourcing new business when moving up the ladder…

10:15 AM: Spoke too soon – a big client request comes in, and it’s a good client so the price needs to be very competitive.

This is a double-edged sword: you can take a lot of P&L upfront on the trade, but you know that getting out of the position is impossible and will take a couple weeks. So you price it with the help of the senior guys on the desk and get back to Excel.

12:00 PM: A company you’re following announces a profit warning – unfortunately, you have a short gamma position and the stock is down 5%. This is one of the situations you hate to be in.

NOTE: This is bad news because gamma is the second derivative of an option’s value with respect to the underlying stock price… so if you’re long gamma, you benefit from stock price movement, and the bigger the better. If you’re short gamma that hurts you because you’ve bet against stock price movement and now the stock has just made a big move.

Because of the short gamma, you are long a lot of delta.

Do you sell the shares 5% down, or hold on and hope it rallies back?

As a personal rule, I like to keep my delta’s from my short gamma’s to a certain limit, and I hedge so that it never crosses that limit.

You do not want to be stuck with a stock that drops 20% in a day and just sit there watching it. It’s important that you know everything about your short gamma’s, more so than your long’s, because if something gaps down you need to know the impact on your P&L and delta.

With longs it’s fine because of the positive P&L, but negative P&L always brings more senior attention and means that you’re more likely to get questions on what you’re doing.

You also need to make sure you know not just your local risk, but also your risk as spot prices move.

In a client flow book you have thousands of positions, so your risk can quite easily flip as parameters move. That is why you need to look at your risk in three dimensions: time, spot, and volatility.

These added dimensions make derivatives more interesting than delta one products (e.g. futures, forwards, or anything else with a linear, symmetric payoff profile), but also harder to risk-manage.

12:30 PM: The stock has calmed down so you get back to Excel, keeping an eye on the chart in the corner of the screen in case there’s any follow-up movement.

1:30 PM: You attend an IT meeting for 30 minutes, where you’re really just listening to updates on various projects that they’re working on for trading desks.

2:00 PM: You get back to the desk to find 10 prices waiting for you. Lock back into the cockpit.

Pricing becomes routine after a while. This can become dangerous, especially with very small requests.

You have to make sure that for every single price, you are very rigorous in assessing all the different risks; you can easily get picked off because you missed an announcement in a company conference call that dividends were being changed or restructured, for example.

3:00 PM: You have a big short gamma expiry today that is OTC and has just rallied close to the strike. Pin risk is very real.

The stock is trading just above the strike and you are fully hedged, which means that if it dips below, the delta flips from 0 to 1 (or 1 to 0 but it has the same effect), so all of a sudden you get very long delta if it’s a sizeable position.

A long delta position isn’t a problem if the stock stays near that strike, but it could then drop 3% and you would lose quite a bit in that scenario.

However, if you sell shares and it comes back up through the strike you get short a lot of delta. This situation gets even worse if the stock is illiquid and you get long/short several times the daily volume.

Your choices are very limited at these times, and you need to be aware of the strike risk days or weeks leading up to the expiry so you can plan accordingly.

4:00 PM: You slowly start hedging the smaller delta positions on the book so you can spend the last 15 minutes focusing on the 10-15 large positions and expiries.

This is one of the most hectic times of the day, as you need to hedge quite a large percentage of daily volume for a lot of stocks.

In addition, several prices come in for clients, and you are trying to finish off some stuff you have been working in the broker market.

On a standard day there are 20-30 things you need to be on top of, and so mentally it does stretch you a bit. Another tricky thing is that different markets close at different times of the day, so you can’t necessarily stop paying attention or finish up right away as soon as the market of the city you’re in closes.

4:35 PM: The markets close, so you finish off all outstanding bookings before running the final P&L for the day.

Technically, your day is done once you submit the P&L, but you normally stay until 6 PM to work on your longer-term projects and think about new trade ideas.

It’s the only time of the day where you don’t need to monitor something, so it’s actually the most productive time for “new business generation” as well.

6:45 PM: Wrap things up and head home.

This is a guest post from “DerivsTrading,” an experienced options trader who has worked at both bulge-bracket banks and hedge funds in London. He defied the odds and broke into sales & trading coming from a non-target school.

The post A Day in the Life of an Options Trader at a Bulge Bracket Bank: From Delta to Vega and Back Again appeared first on Mergers & Inquisitions.