Discover more from Quantitative Traitor
Risk vs. Reward: An interview with Jennifer Wilson
On August 15, 2023, Kevin D of Quantitative Traitor interviewed Jennifer Wilson, a partner at DRW. Jennifer leads DRW’s Risk and Communications departments and is an active leader of the DRW Foundation. Outside of the office, Jennifer is a competitive sailor. What follows is a lightly edited transcript of the interview.
Special thanks to Guy King of DRW for setting up the interview and making it happen.
Thanks for reading Quantitative Traitor! Subscribe for free to receive new posts and support my work.
Kevin D: You got your start in the trading industry with a summer job working for your brother, who was a trader in the Eurodollar options pit. What was that like?
Jennifer Wilson: The Eurodollar options was a relatively new product back then. Eurodollars are a short-term interest rate products. At the time, 4 futures months were traded — today there are 20. It was a simpler product back then.
The Fed didn’t communicate its plans with interest rates back then, instead you had to infer based on what was happening from the trajectory of money supply. So, it was a very different approach. It was Alan Greenspan who started introducing transparency into the Fed Target rates process, and subsequent Fed chair-people expanded that transparency further. There was a lot more volatility due to uncertainty over what would happen with rates.
The trading pit was a huge space filled with people, which is the exact opposite of what we think of as trading today — today it is highly electronic and technical with tons of server rooms. I started before you could even wear headsets at the CME. People communicated via voice and line-of-sight using hand signals, which we called arb signals.
The futures pit was the bigger pit, and it was divided up among different expiries. The options pit was smaller, and the two pits were right next to each other. The information of what was traded in the futures pit needed to get to the options pit because the price of the underlying was important for pricing your options. People stood there and signaled: it’s 2-3, it’s 2-3 — 3’s are trading, it’s 3-bid, now it’s 3-bid-at-4.
If an options trader needed to put a futures order in, they’d signal that with hand signals to a broker or, more likely, their clerk. The clerk put the order into the futures pit via a futures broker, managed the order and let the options trader know when it was filled. That’s one of the jobs I did as an intern — managing the futures orders, which was actually one of the hardest clerking tasks. If you made a mistake — bought instead of sold, put in an order for the wrong month or got your totals confused, it could be very expensive.
You also had people checking the trades, inputting the trades into the system and then checking that they were input correctly. The very first summer I came to work, it took us all night to run the risk analysis of the position. If you mis-punched a trade, ran the output, saw it was wrong and so needed to run it again, you weren’t set up to trade the next day. Double and triple checking everything was key — so there was a lot of detail oriented, manual work.
Since trading was via word-of-mouth and line-of-sight, it was the trust factor that made all of the mechanics work. You couldn’t say: I’ll buy them and then say never mind; I didn’t actually want those. If you did a trade with somebody, they looked at you and said “done”, and both of you carded it up — that’s a good trade. If someone tried to back out afterwards, people wouldn’t trust them in the future and would be less likely to trade with them. So, the system had a natural, self-reinforcing mechanism built into it. It’s amazing that thousands of people and millions of dollars were changing hands under that simple process of trust for so long. It’s only quite recent that the mechanics of trading have become electronic.
Another strange anomaly of the pits was that taller people who could see over others at what was trading had an advantage. The space was tight, people were constantly fighting for their personal space. The bigger and stronger you were, the less likely you were to get pushed around as easily and so that was an advantage. Many traders hired clerks partially for their stature. There was a large proportion of serious basketball and football players who got clerking jobs when they didn’t make the big leagues. That’s a different access into trading than the top university pipeline we think of today. Something that stood out in the early DRW days was that Don’s clerks tended to be shorter than the floor average. Everybody else hired mostly for height first and brains second, whereas Don hired for brains and potential without consideration for the height factor.
My last summer in college, I worked for DRW in the London office. At that time, the Bund options and futures were on the LIFFE exchange, which was a traditional open outcry exchange. Don and several other traders from the Eurodollar options pit had come over to trade the Bund options. At this time, there was an upstart exchange, Eurex, based out of Frankfurt, which had also listed Bund futures, but these were on a screen. The two contracts were look-alikes in every way, but on different exchanges. We — like many others — traded the Bund futures “arb”, meaning that we kept the pricing of these two markets in-line. To effectuate this, a trader stood on the floor in the Bund futures pit, and he had a clerk who sat upstairs, looking at the screen and quoting the prices on the screen all day long. The clerk went on a two-week vacation while I was there, so I got to do this role for those two weeks — which was the hardest job I’ve ever done. I sat there, stared at this old-school black screen with green numbers and quoted the market all day — 2-3, 200-by-500, 2-3, 200-by-100, etc. for 20 minutes straight, while the trader on the other end would be dead silent. Then suddenly, every so often he’d yell “buy ‘em”, and I tried to buy the offer faster than the other arbitragers. And I wasn’t usually fast enough. It was so hard.
That was an early example of low-latency trading — one with very little technology. Notably, that market was one of the only examples where a new exchange successfully competed for market share in an existing successful product — and got 100% market share and ended up crushing the incumbent product. I think it was about a 1-2-year transition. Since then, many other exchanges have tried to list look-alike products and outcompete for the open interest from another exchange, but to the best of my knowledge, none have been successful.
KD: Before joining DRW, you worked at Signet Bank. What was that experience like?
JW: I got a job at a regional bank in Richmond, Virginia after graduating from college. They had built a large analyst group — an early quant team — and they built a huge database. They brought in SAS, which was pretty sophisticated statistical software. The analyst group cranked away at a variety of quantitative analyses. But I was unique — I was assigned to the mortgage team, and I priced portfolios of mortgage servicing that the bank could bid on. I also helped with hedging their interest rate risk in their mortgage pipeline and other analyses surrounding interest rates. It tied in well with my prior experience at DRW.
That bank got bought out by another regional bank, which probably got subsequently acquired. The acquisition strategy didn’t seem smart to me: a lot of the bank’s value derived from the analyst group, but the acquirer didn’t attempt to keep that talent. They said:
We’d love to have you all come and work at our headquarters in Charlotte, North Carolina, but we know not all of you will want to come. So, come to work, but it’s fine if you spend your time interviewing and working on your resume.
That was a strange acquisition strategy. Many years later DRW did an acquisition that I helped lead. My early experience really colored how I thought about making sure the people that joined us understood their role in our organization, how much we valued their skills and how excited we were to have them join us.
KD: What was it like starting out at DRW as a full-timer?
JW: At that point, we had just dipped our toes into upstairs trading. Prior to the late 1990s, we mostly only had people on the floor. When it was time to go to the trading floor, we locked the office door, and everyone went downstairs. During the mid to late 1990s, Globex — the CME’s version of electronic trading — got up and running. Initially it was only at night — there were the floor hours, and then Globex turned on at night. That was still the case when I got there. Over time they opened the electronic market at the same time as the floor, but that took a while.
We had many people still going to the floor and a few people trading upstairs and doing other things like programming. We had a theoretical nuclear physicist, Lester Ingber, working for us and doing research — my first job was programming and quant work for him. We published a few papers together. He was interested in applying stochastic methods he came up with to different data sets. I helped him with the financial markets aspect, and he applied his stochastic analyses to the Eurodollar markets to study the volatility of volatility of the Eurodollar futures. Out of our joint work, we developed a trade related to fixed income volatility products, and I moved over to manage that trade. It was fun to do research, build a trade, and then actually go and trade that trade. I think that end-to-end experience is one of the best you can have in this industry.
KD: What were some challenges you faced in your early career at DRW?
JW: The biggest challenge always is and remains that the markets are challenging, and they are getting smarter and more efficient all the time. So, just as you mastered something, there was something else to learn or the market changed. Don likes to say that markets are Darwinian because the successful participants make money and have more capital to deploy, and unsuccessful participants exit. We’re always trying to think of improvements. How do we price better and faster? What’s another trade we could be doing?
KD: DRW entered the energy markets in 2002. What was going on in the energy markets back then, and what opportunities did DRW see that justified its entry?
JW: Before Enron blew up, the bulk of natural gas trading and hedging was done bilaterally.
After Enron blew up, firms with bilateral risk to Enron lost a lot of money, motivating the market to move to the cleared space instead. That opened the opportunity for the exchanges to get that market share, which previously had been bilateral. This is a good example of a time where the market adjusted efficiently to a major change. There was no regulation that forced these markets to move from bilateral to the cleared space. It happened naturally, driven by market forces.
Also of note, before fracking, natural gas prices were much more volatile than they are today. The nature of the volatility and seasonality of the product in the 2000s made for some interesting quantitative modeling.
KD: Tell me about the history of DRW going from pit trading to electronic trading. What was going on at the time?
JW: DRW was one of the first users of Globex after it launched. As I mentioned, it was only a nighttime platform at first. At some point, the exchange decided to run the screens in parallel with the pit markets and at that point the gradual move away from the pits became inevitable.
The cost of not only the real estate, but also the infrastructure to maintain the pit, the pit reporters, the traders and the brokers must have been quite high. Additionally, the screens were naturally much faster than the manual process and markets always preferred speed. Someone looking to hedge their risk wants to ensure that they are trading off of the most up-to-date price possible, so a slower market will lose liquidity over time. The exchange managed the transition for each market differently based on what was going on with liquidity, but ultimately all the pit markets closed, with the exception of Eurodollar options (now SOFR options post the LIBOR transition) — that pit still remains open to this day. It was closed briefly during COVID, but reopened, so there must be value there.
The Eurodollar — now SOFR — options market lends itself to very complex spread products and the end users tend to be sophisticated financial institutions. As I mentioned, there’s 20 different futures. There are options on many of those. There are serial options, which are shorter-dated options — monthly expiry options. There are also short-dated options on longer expiry futures, multiple expiries of short-dated options. There are all these combinations of options and then all the strikes and any combination of those, so there’s a lot of varieties of packages that people may trade — that market doesn’t lend itself as well to electronification.
KD: What were some market events that left a lasting impression on you and your career, and why?
JW: Here’s one from within DRW: In early 2004, the rates market was trying to figure out when the Fed would raise rates. The futures would move and then go back, and then again, they’d move and then go back — however, the option skew remained steady. Then one day, the futures moved, and the option skew also flipped. The market became convinced that the Fed was now actually ready to start hiking rates. We had of course always talked about skew – the concept of different options strikes trading at different volatilities but didn’t have an adequately effective way of measuring and quantifying it. DRW ended up losing a chunk of money on that move — it was depressing.
After a week of managing through some large market moves, Don called everyone into the office on a weekend and said:
This is so exciting. We have just paid a lot of money in tuition, and now we need to make sure that we learn a good lesson from this — we’re going to come up with a way to quantify skew better.
So, we spent a lot of time thinking about the best way to measure skew, what units to look at it in, etc. Then Don wanted to know how much skew risk every single product we traded had — every strike, call and put, and every combination spread that we traded. Are we increasing or decreasing our skew risk with each trade? Floor trading is already hard enough and making changes to your process was very difficult. So, some traders didn’t really want to have to incorporate an additional measure of risk — we already have gamma, vega, theta etc. so why another measure? Don was very firm:
We must add our new risk measure to the sheets. I want everybody to be thinking about it — I want everybody to add up where our skew risk is before the trading day starts and after the trading day ends, and we’re going be on top of this moving forward.
That was a good lesson in not only making lemonade out of lemons, but also building a lemonade franchise. We had a loss, we messed up, but let’s figure out what we can do better next time and going forward. That mentality is something that I think is really important.
KD: Today you are the head of risk at DRW. How did you get your start in risk management?
JW: I was trading — this was a long time ago — and we had several different desks, but no overarching process bringing all the desks together. I was asked to take that on.
Many years later, our approach to risk management remains at its core the same: understand the particular risk that each trade is purposefully taking on, quantify that risk and define how much of it the desk takes on. Don’t take on risk that isn’t fully understood. The skew example that I gave earlier is an example of a trade where we had risk that we couldn’t properly quantify and that was the mistake and ultimately a learning opportunity.
KD: DRW does roughly three different kinds of trading: (1) traditional liquidity providing, (2) risk-taking businesses and (3) algorithmic trading on a faster timeline. Tell me about that.
JW: We used to talk about our trading distinctly as these three buckets — liquidity providing, risk-taking, and latency-sensitive trading and DRW is unique in how diversified we are, both in terms of market approach and asset classes. But in modern markets, those three have really morphed. Many of our desks serve the markets using strategies that fit into two or three of those buckets.
KD: How did DRW deal with the 2007-2008 financial crisis and the ensuing regulation designed to reduce the risk of another financial crisis?
JW: There was a lot of uncertainty and volatility, which tends to be a good time for trading because you have a lot of participants in the market in search of liquidity to execute their strategies. We were one of the participants who bid in CME’s auction of Lehman’s cleared portfolio. I guess that Lehman had defaulted on their cleared portfolio at the CME’s clearing house. The clearing house was looking to liquidate this risk, so they broke it up into portfolios by asset class and reached out to a select number of market participants to ask:
Could you please take a look at this risk? What do you need to be paid to take this risk?
We went through that bidding process — we came in at 3 AM to value the risk of these books. We ended up taking down, I think it was three of the five portfolios from that auction. At the time, that was the biggest trade and biggest day for DRW.
This auction is an example of two important things: A time where the clearing process worked as designed and also a time where markets worked — and worked really well. First on the clearing side — let’s be quite clear as we are all a bit jaded now by the FTX debacle — what occurred in 2008 was a huge default by a major market participant and no CME customer was harmed. The CME opened, on time, every day, the clearing process ran smoothly and markets continued to function. Why did that happen? To my knowledge — and I’m not speaking for the CME here, I wasn’t there — they had the flexibility to approach the situation in a condition dependent way. They were not required to follow a particular playbook, in a particular way with particular timing. I feel like we have a tendency right now to believe that more rules, with a lot of detail and more specificity will make our institutions and hence the public safer in the next bout of market volatility. This approach is a fool’s errand. The future is always out of sample and when the time comes, we won’t be fighting the last war and those specifics will just gum up the works. In my view, it’s better to set guardrails and principles that allow for the flexibility to make judgement calls based on the particular situation at the time. There has been great handwringing about markets “seizing up” more and more and that is as a direct result of regulation that is too proscriptive.
The second point I want to make about this situation is that the markets continued to function smoothly. People who needed to offset their risk were able to do so. Did spreads get wider? Of course they did, which was completely appropriate given the uncertainty in the economy and with interest rates at the time. Once again, in order to be able to continue to function well, markets need as few choke points as possible. If there had been rules back then about how wide prices could be, people would have stopped quoting completely instead of just widening out. If there had been rules that cash treasuries have to be traded out of a regulated entity only, they would have just stopped trading. In order to be able to quickly adjust to market turmoil, capital must be able to flow smoothly. The additional specificity that regulation has added in the interim only cuts down on the market’s ability to adjust to conditions in the moment.
In terms of the ensuing regulatory change, we embraced it — as a firm our view has always been that thoughtful regulation is good for the markets. And in this case, we believed more cleared products would be better for the marketplace as it would increase competition versus the status quo of only having those products traded bilaterally.
But how the swap dealer rules were written — the regulatory scrutiny and additional hurdles businesses take on with applying to be swap dealers are tremendous. Not many have chosen to become swap dealers, and I’m not sure that worked out the way regulators intended. It’s a good lesson in how precise these rules have to be and for me, a reminder that intention doesn’t matter, the outcome to the market does.
KD: You work closely with DRW’s Montreal office. DRW acquired Vigilant, a Montreal-based low-latency prop shop, back in 2013. Tell me about that history.
JW: In 2012, an acquaintance of an acquaintance of an acquaintance suggested we talk to a group of people in Montreal, so we flew there to meet them. Their technology skills and approach to the exact same markets we had been trading for years were novel and unique. The parties agreed there were synergies between the two firms, and DRW acquired Vigilant in January 2013. I acted as a liaison between DRW and Vigilant for the first few years — I made many trips to Montreal and got to know that team well. There were about 90 people when we acquired them, and our Montreal office has grown to 270 people today.
KD: You concluded a talk you gave for MarketsWiki Education’s World of Opportunity back in 2017 by leaving the audience with the advice of (1) owning up to your mistakes and (2) always honoring your trade. What are some examples from your own career which taught this advice?
JW: Those are just basic pit approaches. As I said earlier, you’re checking trades, typing things into the system and double checking what you’ve entered. The market is moving all the time. You think you’re hedged. You think your book is delta neutral. You think if the market moves 10 basis points from here, you know exactly how much money you’ll make or lose, and you have your risk well-understood and well-confined. If the inputs to those assumptions change, you better raise your hand fast so that the risk can be adjusted.
KD: Some parallels between trading and sailing include winning, risk vs. reward, and the importance of hard work and teamwork. Given your expertise in both those areas, what might be some less obvious parallels between the two?
JW: Within for example risk-taking trading, you can have a systematic risk-taking strategy. You can focus on macroeconomic analysis. You can focus on something very specific like the Fed’s impact on short-term interest rates vs. some other products. There are many different ways of approaching trading and the markets, and sailing has many different aspects to it also:
There’s the physical aspect of the work of sailing; some sailboats are more physical than others. There’s the physics of boats moving through the water and moving upwind. How do you trim your sails optimally to get the best performance out of them? How do you design a sail, much less a sailboat? I’ve mostly been doing so called “one-design” sailing, where everybody shows up in the same type of sailboat, and the race is about getting the best performance out of those identical boats.
On top of the physicality and sailing of the boat, sailing also sets up like a chess match on the water. The wind is moving and changing all the time. The wind might move 10 degrees to the left and 10 degrees to the right and so forth. If you’re trying to sail upwind and can anticipate those oscillations and tack at the right time, you’ll sail too windward faster. There’s also the concept of a persistent shift, which is when the wind moves gradually in one direction only. If you think the wind shift will be persistent vs. oscillating, you set up your strategy differently.
You mentioned risk vs. reward. Where you set up your boat vs. the competition is important. If you’re fortunate enough to be in the top of the group, you can cut down on your risk and make sure that you’ll always be staying between your competition and wherever the next mark is. Or if you are further back in the pack, maybe it’s better to take some risk and go to one side of the course if the competition isn’t going there.
KD: What are you currently up to with sailing?
JW: The past few years, Don and I have both been sailing a boat called an M32, which is a high speed, semi-foiling catamaran that’s 32 feet long. I sail on one team with my niece, and Don sails on another boat, so we are competing against him as well as the rest of the fleet. We have a very good team, and we’re excited to see what we can do this year. We’re the only women racing these boats lately — we need to get more girls out racing on M32s. ■
Thanks for reading Quantitative Traitor! Subscribe for free to receive new posts and support my work.