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Remember the GI Joe with the Kung Fu Grip?

Remember the GI Joe with the Kung Fu Grip?

Posted January 3, 2022 at 12:15 pm
Steve Sosnick
Interactive Brokers

Join us and have a listen to the first episode of Trader's Insight Radio! Andrew Wilkinson, Director of Trading Education at IBKR and Steve Sosnick, Chief Strategist at IBKR discuss a number of topics such as market activity, IBKR's past and future, and more!

Summary

Andrew 

Welcome to this first edition of Interactive Brokers Radio podcast.  My name is Andrew Wilkinson and I'm the director of trading education here at Interactive Brokers, which means that I'm responsible for ensuring our clients know how to use our various trading platforms. We're going to look back in this first episode at how Interactive Brokers has grown from a small options. Market maker into a NASDAQ listed global broker dealer with a market capitalization in excess of 30 billion. As a broker dealer, Interactive Brokers connects it's one and a half million clients to 135 markets electronically in 33 countries using 23 currencies more than 20 years ago I was a London trader and watched the revolution from hectic open outcry on traditional trading floors to electronic screen based dealing. 

The very first market that Interactive Brokers made electronically available to its clients back in 1993 was the German government bond market. Now during the 90s, this market was one of the world most liquid and demand for German debt was raging on account of the transition towards ever lower inflation and the onset of the single European currency. Everyday trading volumes were huge. Over time, Interactive Brokers has built out more products on more electronic markets and today the company trades more than most US electronic broker dealers since we cater to active and professional investors. 

I'm joined here today by my colleague Steve Sosnick.  Welcome Steve. 

Steve 

Thank you Andrew. 

Andrew 

Steve is Interactive Brokers chief strategist. Steve you joined the company before the Electronic Revolution happened in Europe. Tell us a bit about what a dealing room looked like at that. 

Steve 

Time well, first of all, it was before the electronic revolution happened pretty much anywhere in the world.  When I joined most of the people who worked for Timberhill, which was the firm at that point, were floor traders. I joined in December of 1995. At that point we were moving from. Trading index options using sort of PC monitors that flashed colors into the pits and transitioning toward what I would call Proto iPads almost.

They were laptop computers with touch screens, but they were very, very underpowered considering what you could do now. And so you know, the traders would sometimes go in there with like four or five machines. I don't know how some of these people would not have back problems. And you know they would somebody walk in the crowd. “IBM March Park calls?” “What's your market?” And you know they type it in there.  Or you know, quarter or half kind of thing. 

And done, and then they put in the trade and it would get it would get transmitted electronically, up to up to headquarters in Greenwich and we would constantly be adapting our model based on all these inputs. 

Andrew 

So Steve, so were you sending a message down or we're using a phone to communicate with them on the floor? 

Steve 

No, no, it was done electronically. 

Steve 

The guys in the pits before that they would do the trade and signal it out to their clerk who would then input it, but it was done electronically.  The handhelds were communicated electronically. I really wouldn't talk to them. Even then, we were communicating prices to the traders and getting the trade reports back all electronically. 

The problem was you couldn't really trade with another trader electronically. Almost all trading was done open out.  All the pricing information that was available to us, combined with all the position data that was available to us and sending fresh prices more or less upon requests to each trader.  When they needed to see what was going on in a specific line. 

Andrew 

So tell us what you were doing at a granular level. So this this is the options market, right?  So where does an order come from? It arrives on your desk. What do you do?  What are the elements to your job at that time? 

Steve 

At that time I was hired because we'd started to move in a big way into individual equity markets going beyond the big indices at the time, which was really OEX. The CBOE 100 index, the S&P 100 which was traded on the CBOE was the biggest option that would trade. And there were you know the S&P futures etc. We started to move into individual equities, needed a person who had an equity trading background. As well as a derivative trading background. That person was me.

Basically my job in those days was first of all develop protocols for understanding our risks at any given point.  You know, are we on side or off side?  Are we building up too big of a position in one in one sense or another? And if so, why?  And if so, adjust the prices and start to develop regimes for pricing in what I would call the known unknowns, earnings, earnings events or other corporate news that would come in. And all these required tweaks to the model and of course, making sure the model works

Andrew

So how big a business is this?  Back in the mid 90s, we're talking options again. So the company behind this, which was the forerunner of Interactive Brokers, was Timber Hill. Give us some perspective on Timber Hill. It's size in the industry and its importance. 

Steve 

We were well known among people on the exchanges, but outside of the options industry no one knew who we were, which was the same with many of our other big competitors. You know, no one knew who Susquehanna was, or Wolverine, or some of these other firms. We probably had a few hundred floor traders at that point. 

Andrew 

And this is across multiple exchanges in. 

Steve 

This is in the US and this is in the US and internationally. At this point, we were growing steadily in that in that period because I think what we were doing was a bit ahead of the game. 

Andrew 

And I think when I joined the company in 2007, I remember couple of statistics thrown at me about Timber Hills global footprint and its US footprint. I think globally Timberhill traded about 13% of equity options every day and around 15% across North America. 

Steve 

That sounds about right, yeah.

Andrew 

It was a large footprint, which is pretty substantial. 

Steve 

Yes it was very large footprint, you know.  And along the way we did expand.  By the time I arrived there was an office in Hong Kong, then there was an office in Zouga, and we were trading in most of the major European markets and certainly Hong Kong. I think we I think we were up and running in Australia by the time I arrived. I started Timberhill Canada in the late 90s and you know it's been steady growth

Andrew 

But that was a very important aspect of making Interactive Brokers what it is today.  It has a global presence and I and my understanding is this: That we would roll out to exchanges across the world, become an exchange member and that's what's that's the legacy today. That we're able to make our products and services available to a global client base, right? 

Steve 

I should give you a more interesting answer than yes, but yes. 

Andrew 

All right, so looking back at your career, you've covered bull market bear market. You've seen an awful lot. Can you capture for us a bit of the drama throughout your career? For example, what does the .com, boom and bust look like after 20 years?

Steve 

Well, it's interesting because at that point I like to draw a lot of parallels, then to now because there are a lot. In the late 90s there was a huge democratization of investing, and the public was able to discern or intermediate from using calling a broker to typing into a terminal. You know we were one at that point. I mean, we didn't advertise to the way that like Ameritrade or Etrade did, so in mindshare, they definitely seemed bigger. But that was a big turning point in terms of getting people involved and the options market exploded and you knew at this point that there were some crazy stuff going on.That the Internet was for real. But you know many of these stocks were, you know, pretty much phony.

I will say among our best years were 2000 and 2001 because volatility exploded, spreads widened. We tended to do well when times were chaotic. In terms of annualized returns, two of our best years, probably the two best years that we had.

Flash forward to now, we've had this huge democratization of investing. Yet again, you know, sort of new apps that make it even easier. We as an industry we made it free of major brokerage firms. We beat Schwab by I think a day or two to go to free commissions, as an industry we enabled fractional trading. All these are things that democratized investing. That sounds familiar, right? 

And in the late 90s you had the Internet coming into vogue, and I think you didn't have to be a huge futurist to know that there was something meaningful about the Internet. But you also realized that a lot of the companies that were out there were we're really kind of dopey, you know, pets.com is whenever he brings up, but then there was the Globe.com, which was sort of a proto social network. 

You know there were all kinds of crazy.  It basically clicks with a measurement, nothing to do with profitability or in many other in any real sense. 

Andrew 

Well profitability didn't exist at it. 

Steve 

No, and when we look back there's really only one company that came of age in that era that has survived and thrived, and that's Amazon. And you know, people said, well, what about Apple? What about Microsoft?  No, they were around before hand. And the other ones Facebook, Google some of these we could rattle off a whole bunch more Netflix, etc. They're all post Internet bubble. And what I see now is that sounds an awful lot like blockchain and cryptos doesn't. 

Andrew 

It right and people are asking that very same question. You know, isn't this just another crazy boom that's going to go bust at some point?

Steve 

Let me ask sort of ask and answer a question. Would you have this mania in cryptos and NFT's if we had positive real interest rates instead of negative? Real interest rates. I'm going to say no. And what kind of brought us to a late 90s to a close was you had this robust economy, but the Fed was continually pumping more money in because they were deathly afraid of Y2K with good reason. Let me not say that's a mistake. 

Y2K came and went more or less uneventfully, which was good. So what did the Fed do? They started to withdraw liquidity. Well, it wasn't immediate, but you know, sort of March 2000 where we peaked. And as the Fed started to remove the Y2K, liquidity the unsustainable you know, became unsustainable, and that's kind of what I think now: Is which cryptos will be the Amazon, so to speak? And which will be the petscom? My gut tells me is things that are named after pets are more likely to end up like pets.com. Let me just put it that way.  Well, we we we can't. 

Andrew 

Move this conversation along without pausing at 2007, 2008. So what did your book look like then? You were trading financials for a lot of your career, right?  So what were some of?  The highs and lows or were there just ever increasing lows? 

Steve 

Oh, that was tough. But I will say we stayed fairly ahead of the curve.  I'll relay one conversation, and this is where you never know where things have.  Is one day in 2007 I get in the elevator and the door opens a floor higher in walks. Thomas Peterffy. Now at this point he sat very close to where I sat. 

Andrew 

And let me just explain to the audience Steve exactly who Thomas Peterffy is. He's one of the architects of the options market from back in the 70s. He's the founder of this company.  And until a couple of years ago was the CEO and he's now the chairman ofthe board. And our boss. 

Steve 

So for those of you who are actually listening to this and had and didn't know who he was, that's thank you. But you know the door opens and walks Thomas and it's like, you know he's not a small talk kind of guy, so you know “what's new”. And I said, you know, I don't like what I'm reading today in the Wall Street Journal and that is that Bear Stearns has some hedge funds that could have liabilities as high as $20 billion. 

Andrew 

And that's not a small. Number

Steve 

No. And he said how big is Bear Stearns. He said probably about $20 billion. And he looks at me and goes are you telling me that you think Bear Stearns is bankrupt? I said I'm not going to go that far, but uhm, I think yeah, there's a reasonable possibility that yeah, could be. 

Uhm, he responded with expletive deleted and basically said more or less don't be short puts in bank stocks from here on out.  And I made it my job not to be. 

It was that it was a very tough challenge because you really couldn't, you know, the flows were enormous, but I wouldn't say we handled it without ever hitting a pothole. That would be unrealistic and and overstating it, but I would say our positioning tended to be risk averse.  During a very risk averse period. 

Andrew 

And so, having weathered all of those storms so… I started off deliberately talking about Timber Hill because it was the mainstay. It was the bread and butter of this company. 

When I joined 2007, I think 30% of the revenue of the company came from the brokerage side and 70% from the from the options market making side. And I know Thomas’ his vision for the company was to reverse that. That's very much happened. So, what is it that we've done as a company, or that that Thomas and management has done to make this company grow so effectively over the last couple of years?

 Steve 

Well, I think the original vision of Interactive Brokers was we had this trading operation and wouldn't it be nice if we could feed this trading operation. Over time, that outgrew the proprietary side there. Kind of a limit to how big a proprietary broker can be. 

You certainly can't be bigger than the marketplace, and once you hit a certain level of concentration it doesn't work because no one to trade with. And so you know, I think the brokerage firm had fewer limits upon its growth than the prop side did. There also became a concern among customers that we were internalizing all kinds of things and that really wasn't the case. You know, we've been very committed to best execution for our customers, and I mean real best execution. Not like, you know, sort of a fake best execution that is within the rules but isn't really best execution. 

Ultimately, there was no better way to prove that than by saying look we have no conflicts with our proprietary trading. We became Interactive Brokers and the dealer went from being the parent became the child is really what happened. 

Andrew 

So in that in that time frame, we've gone from 600-700 employees to more than 2000 these days, I think. And we've expanded massively in terms of different roles, different departments, and so on. One of the really important departments nowadays is education.  What is your role in the company these days and how does it fit into educating the client?

 Steve 

My role has become and kind of became this way accidentally. They were nice enough to let me start talking to to the press and writing guest articles and magazines and stuff of that nature, and that became a a job in and of itself, and my feeling is I try to put regular content on our website and via media appearances as well. But the main focus is putting content on our website that hopefully teaches people how to think about the markets. 

I'm less nuts and bolts than you are in terms of I'm not, you know, I'm not going to necessarily spend the day explaining why a vertical spread is better or worse than an outright, but I want to make people think about what they're seeing and why. You know why is the market doing what it is? Why is volatility up? Why is volatility down? How is what the feds doing going to influence stock prices? This is whether it's today, tomorrow, or over the coming year, and that's my role in trying to educate people. 

You can't make money all the time. My feeling is first of all, don't lose money. You know, I think a lot of trading is about avoiding losses as much as it is about maximizing gains. Because you know too many people, I think swing for the fences. 

This is what scares me right now is, I think, a lot of customers. I mean you look at how many customers we've gotten since March of 2020. If they're new to the markets overall these people have never seen a tightening cycle. They've never seen a market that doesn't go relentlessly higher. They've never seen a fed that or central world central banks that aren't like flooring it all the time. This is the first time that the feds taken their foot…they told you they're taking their foot off the accelerator. 

Somebody used the comment the other day. I wish I remember who it was. I wish I could quote her, calm seas, make lousy sailors. And I'd never heard that. Before I thought it was brilliant and that's why I wish I could give the quote because. Uhm, anybody who started investing if they're doing well.  God bless you. You can't assume this is the way it always works. It's an anomalous period. 

And extended even further, there's a whole generation of investors who came in the market in the aftermath of global financial crisis.  So that's 12 years ago already and they really haven't seen a market where you know couple of times the Fed had a slight hiking cycle, the Fed had the taper tantrum.

The central banks have been very reluctant to remove liquidity or reduce liquidity, and that becomes, you know, if they're sort of sincere about reducing their balance sheet, sort of reduction of stimulus, and actually some sort of reversal of stimulus.  You know this is a very uncharted period for a lot of people.

Which is why my big concern for 2022 is that I think people are going to get rocked by volatility here and there.  And that doesn't. That's not necessarily a bad thing. Volatility creates opportunities, but the half life of the buy the dip seems to be getting continually shorter. And I think that's not right. There's the concept of “The Fed put”. I've said various times I don't know where it struck. You can't assume it struck 2% below the market. Yeah, and so. 

Andrew 

So Steve, we can find your articles perennially on tradersinsight.news and they are extremely well read. You'll also find those in Trader Workstation under Traders Insight News. 

Have you got any favorite TV stories for us? Off the top of your head.

Steve 

Yeah, my favorite one so far was I was on Bloomberg one day around this time of year holiday season. And markets were acting poorly at this point, and you know, they said what's going on out there and I said it's the GI Joe with Kung Fu grip problem. 

And the hosts she sort of looked at me like, huh? Meanwhile we get through it and it ends, at which point she's like, what did you mean and at the same time all the crew is high fiving me. Because they knew that the reference was from Trading Places, and for those of you who haven't seen the movie and you should, there's a lot to like about it. 

Cut to the chase, Eddie Murphy is being taught to trade.  He's a homeless man who is who is suddenly thrust into basically my old job. And is, you know, sort of running the trading at this big commodity brokerage firm and they're teaching him how to trade. 

And the price of whatever it is they're showing them dropping, dropping, dropping, and the two old men who run the firm  The Duke brothers say you know he should buy it and he said no, no no don't buy it yet. There's people worried about their bonus and I'm oversimplifying and they can't buy their kids The GI Joe with Kung Fu grip. Give him another couple minutes for the panic to settle, then you buy.

And of course this being the movies, he finds the absolute trading bottom and up it goes. But that's the GI Joe with Kung Fu grip problem. So I would say that having used that on air, one time, having left the left the host to leave her a little bit flummoxed and have the cameraman and the director, the producer give me high fives for using the reference. 

That was probably my favorite TV moment. 

Andrew 

Excellent, so going forward.  We're going to be doing more of these podcasts. 

What are some of the things you're going to want to talk about with the audience? 

Steve 

What I'm going to try to be doing is talking less on myself because you know what I write a lot and do the videos once a week.  I'm going to try to bring in some of my friends and colleagues to talk about other things about the business.  Get other perspectives. I'd like to think we've done a pretty good job about putting my perspective out there. 

I think it would benefit our clients and our viewership or our listenership to get some fresh ideas.  So I have some ideas in the works of who I want to bring in and who I want to have conversation. 

Andrew 

So Steve Sosnick, chief strategist for Interactive Brokers, thank you very much for joining me today and we look forward to meeting you in 2022. 

Steve 

Sounds great Andrew, thanks. 

Andrew 

Thank you, thanks everybody. 

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Interactive Brokers, its affiliates, or its employees.

Disclosure: Options Trading

Options involve risk and are not suitable for all investors. For information on the uses and risks of options read the "Characteristics and Risks of Standardized Options" also known as the options disclosure document (ODD). Multiple leg strategies, including spreads, will incur multiple transaction costs.

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