Joe Ritchie is the founder and driving force behind CRT. It is his ideas, concepts, and theories that serve as the blueprint for the complex strategies that guide the firm. Although he has never taken an advanced math course, Joe Ritchie is considered by many to be a math genius—a natural. He would have to be, given the intricate mathematical nature of the trading models employed by CRT. Joe describes math as something he almost feels or intuitively understands.
Ritchie would be the first to emphasize that the success of CRT is hardly a solo act. There are many individuals that are integral to the company’s achievements. In our interviews, Joe insisted that I also talk to some other CRT personnel. Here is how one key employee described Ritchie’s philosophy: “Joe believes in empowering people. He trusts people. I sincerely believe that one of the reasons we can make so much money is that Joe makes us feel absolutely comfortable to risk his money.”
Ritchie makes a lot of business decisions based on his gut feeling about the people involved. If he feels any discomfort with the people, he has no reservation about walking away from even the most lucrative venture. On the other hand, he has been known to initiate major operations on not much more than a handshake.
A recent case in point is his venture in launching a computer company in the former Soviet Union. The company is involved in every phase of the production and marketing chain, including developing software, importing hardware, establishing service and trading centers, and implementing a distribution system. This whole elaborate operation sprang to life because Ritchie was impressed by an entrepreneurially inclined Russian whom he met. His trust and confidence in this man was all it took to convince Ritchie to make the investment commitment. As one CRT employee explained, “While every other U.S. company involved in a joint venture in this region is trying to write three-hundred-page legal documents to protect themselves, which don’t hold water there anyway, Joe asked the Russian to write a contract that he thought was fair, and Joe signed it on his next trip to Moscow.”
As might be expected of a man who has built one of the world’s most successful trading operations, Joe Ritchie is dynamic, energetic, and brilliant. Work is truly fun for him because it is an endless challenge and an ever-changing puzzle. But there is another key aspect that delights Joe Ritchie about his work: the people. “I love to come to work,” he booms. And he means it. It’s not just that he loves what he does, but he considers CRT an extended family. He appears to exude a genuine affection for his employees.
When you first started doing silver arbitrage, you had hardly invented the wheel. Other people were already doing the same thing. Did you do anything differently in order to succeed?
We tried to do a better job of understanding the interrelationships between markets and assessing the probabilities involved. We also traded more aggressively and for a narrower margin than the other brokers. We did the same thing years later in options, when by using more accurate pricing models we were able to quote such narrow bid/asked spreads that our main competitors assumed we were making markets that were too tight to be profitable. If you really have the mechanics or theoretical value nailed, you can do a lot more volume at a smaller margin.
How did the other floor brokers respond to your competing for the same type of business?
They resented us because we were so aggressive and were eating into their volume.
But I imagine that back then you had very low capitalization. How could you have been much of a threat to their business?
That’s true. We probably had one of the smallest capitalizations on the floor. Some of the other key players might do a five-hundred-lot arbitrage order, whereas if we did fifty, we would be up to our limit. However, we traded it back and forth much more aggressively, so we ended up with a much larger proportion of the volume than might be expected relative to our typical order size.
Was that a matter of your willingness to take a smaller edge than the other brokers?
That was certainly part of it. But there were a hundred other small things. For example, getting better phone clerks, or coming up with faster ways to communicate between the Chicago and New York silver floors.
I don’t understand. Doesn’t everyone use the telephone? How much faster can you get?
You’re going to find this hard to believe. When I first came to Chicago, we found that a lot of the people who were doing silver arbitrage didn’t even have a phone clerk because they didn’t want to pay for one. Instead, they had a telephone with a little light above it, and when the market changed in New York, the New York floor clerk would pick up his phone, which would cause the phone light to flash in Chicago. When the Chicago broker saw the light, he would run over to the phone, get the quote, hang up the phone, and run back to the pit to do the trade. The transmission time that was involved was so slow that we thought we could easily beat it by getting good phone clerks.
Were most people doing it that way?
About half of them were. But even the ones who were using phone clerks still had a transmission time of about three to ten seconds. We found that if we got the best phone clerks, motivated them, and did everything else right, we could cut that time down to about two seconds.
Essentially, you were doing the trades faster and taking the trades before the spreads widened to the point where other brokers would do them. I assume that approach didn’t make you very popular.
It made us very unpopular. In fact, they tried to throw us off the floor.
On what grounds?
For rule violations, such as the phone clerk verbally calling orders into the pit. Technically, the orders are supposed to be written down and carried to the pit by a runner. However, it was standard operating procedure for orders to be called into the pit. The exchange realized that they needed the arbitrage activity to provide liquidity, so the rule was not enforced. However, that didn’t stop them from pulling us in front of the committee for violating this rule. In the end, they had to drop the issue when they realized that trying to enforce the rule against one party and letting everyone else violate it was not going to work.
You make it sound like a real insider’s club.
It was.
Is that true of most exchanges?
[Long sigh] It varies a great deal from exchange to exchange, but it’s a lot less prevalent than it used to be. The competition has just forced changes.
The silver arbitrage operation eventually came to an end. What happened?
The silver arbitrage was very profitable during 197374 because the market was so volatile. However, when the volatility died down in 1975, the silver arbitrage became a very slow business. I tried to convince the fellow who owned the company I worked for to try something else. I thought that the soybean crush was the business of choice at the time.
(Soybeans are crushed into two constituent products: meal and oil. If soybean prices are low relative to the product prices, then crushing plants can lock in very attractive profits by buying soybeans and selling an equivalent amount of products. This activity will cause soybean prices to gain relative to product prices. Conversely, if soybeans are highly priced relative to products, causing the profit margins to be low or negative, crushing activity will he reduced. In effect, this development will reduce soybean demand, which will decrease soybean prices and reduce product supply, which will increase product prices. Essentially, these economic forces will cause soybean and soybean product (meal and oil) prices to maintain a broadly defined relationship. The soybean crush trader tries to buy soybeans and sell products when soybeans are priced relatively low versus products and do the reverse trade when soybeans are priced relatively high.]
What did you do differently to give you an advantage over other brokers who were doing the crush?
Very simple things. Many of the same things we did in silver. We would keep the best clerks by paying a good wage and providing them with the opportunity for growth. We also constructed our own crude slide rules that would show the implied price for soybeans given different price combinations for soybean oil and soybean meal. This tool allowed us to instantaneously calculate the value of the market, which helped us take advantage of the order flow more quickly. I can’t tell you why the other brokers weren’t doing the same thing, but they weren’t.
Were you still associated with your original company at the time?
Yes. I reached an agreement to switch from silver arbitrage to doing the soybean crush, wherein I would be responsible for all losses but would split any profits with the company 50/50.
It sounds like heads you win fifty, tails you lose one hundred—not a very good deal. Why did you stay with the company under that arrangement? Did you need the use of their seat?
No. It was probably a combination of inertia and loyalty to the company for having given me my start in the business. But eventually I went off on my own.
Was that the start of CRT?
Yes, although the name and the partnership arrangement came later. The move into the soybean complex was also characteristic of what was to become one of our principles all along—namely, not being tied to any one business but rather moving to the markets where something interesting was going on. When we first formed a partnership, the company name was Chicago Board Crushers. Then some time later we changed the name to Chicago Research and Trading.
[Mark Ritchie, who has been sitting in for the interview, interjects.] One of the reasons we changed the name from Chicago Board Crushers was that our secretary got tired of explaining to people who called in why we couldn’t crush their boards.
You’re joking.
No, seriously.
You just mentioned the idea of being flexible enough to switch to the markets that had the best trading opportunities. As I recall, you became involved with silver again during the wild 1979—80 market. Were you just trading the arbitrage, or did you do some directional trades?
Almost exclusively arbitrage. When the volatility expands dramatically, the opportunities for profit in arbitrage are greatly enhanced.
There was one trade, however, that you could term directional. This is one of those stories that proves that it’s better to be dumb and make a profit than be smart and take a loss. In early 1979, some mystery buyer came in and bought twenty thousand contracts of silver. Nobody knew who it was. I did some digging around and found that the person who was managing this trade was a Pakistani. I happened to know a Pakistani who was from the upper crust, and the upper crust of that country is relatively small. So I asked her if there were any Pakistanis who could have that kind of money. She said, “No, but there are two Pakistanis that manage money for the Saudis.” She gave me the two names. Sure enough, with a little secret investigating, we found that one of these guys was connected to the buying. We thought we had a nice bit of information.
At the time, silver options were traded only in London. The out-of-the-money silver calls were trading at very low prices. Even though the market was not that liquid, I bought a huge amount of calls. I took a ridiculously large position relative to our equity base, knowing that our downside was limited. [Essentially, an out-of-the-money call gives a buyer the right to buy a contract (silver in this instance) at a specified price above the current price. If the market fails to rise to that price, the option will expire worthless, and the entire premium paid for the option will be lost. On the other hand, if prices exceed the specified price (called the strike price), then the right to buy offered by the call position can result in profits. If the strike price is significantly exceeded, the profit potential can be huge.]
We had lots of theories about who might he buying all this silver. But there was one theory that we had never considered. It turns out that some guy had passed off a $20 million bum check to a brokerage office in Dallas.
What did that have to do with the Saudis?
Absolutely nothing. Apparently, he wasn’t related to the Saudis. He was just someone who passed a bad check. So while we thought we were being very clever, all our analysis actually proved to be inaccurate. The brokerage company finally caught this guy, sold out his position, and silver prices slid down to under $6. I couldn’t even get out of my position because the market was so illiquid and I held so many options that I would have gotten virtually nothing for the contracts if I had tried to sell. Essentially, I ended up being married to the position.
At that time, I went away for a vacation, which was fortunate, because the Hunt buying started to push silver prices sharply higher. I’m sure that if I were around, I would have gotten out at the first opportunity of breaking even. By the time I came back, the silver calls were in the money [i.e., the market price had risen above the strike price].
Although l thought the market was going to continue to go up, I couldn’t stand the volatility. One day, I decided to go into the silver pit just to get a feel for what was going on. I promised myself that I would keep my hands in my pocket. At the time, silver was trading at $7.25. I decided to sell twenty-five contracts against my calls just to lock in some profits. Before I knew it, I had liquidated my entire position. By the time the calls expired, silver prices had gone up to about $8.50.
The 197980 silver market was one of the great bull markets of all time. [Silver soared from $5 per ounce to $50 per ounce in a little over a year.] Did you have any inkling of how high prices might go?
None whatsoever. In fact, even $10 per ounce seemed extremely far-fetched. I don’t know anybody who bought silver at relatively low prices and got out at over $20. The traders who bought silver at $3, $4, $5, and $6 did one of two things. Either, by the time silver got up to $7, $8, or $9 they got out, or they rode the position all the way up and all the way down. I’m sure there are exceptions, but I’ve never met one. I did, however, know traders that went short silver at $9 and $10 because the price seemed so ridiculously high and ended up riding the position until they had lost their entire net worth. That happened to some of the best professionals I knew in the silver market.
Would Hunt have succeeded if the exchange didn’t step in and change the rules by allowing trading for liquidation only, thereby averting a delivery squeeze?
The exchanges didn’t have to change the rules to prevent Hunt from taking delivery. According to the rules, the exchange has the power to step in and say, “Ok, you want silver, you can have your silver, but you’re going to have to spread out the delivery periods.” Or they can allow trading for liquidation only. If the exchanges had just stood aside and allowed a noneconomically driven demand for delivery, they would have been abrogating their responsibilities.
At the time that the Hunts were standing for delivery of April silver, the forward contracts were trading at huge discounts. The Hunts had no immediate economic need for delivery. If all they really wanted was ownership of the silver, they could have switched their April contracts into the discounted forward months, locking in a huge net saving and also freeing up their capital for use in the interim. Or they could have purchased silver coins in the free market at $35 per ounce when the April contract was at $50. When instead of these economically sensible alternatives they insist, “No, no, no, we want to take delivery of the silver in April,” it indicates that they’re playing a game. That’s not what these markets are here for. So I feel that the Hunts got exactly what they had coming to them.
A lot of innocent parties were hurt by the Hunt activity. For example, take a mine down in Peru whose cost of production is under $5 per ounce. When the price gets up to $15, the mine decides to lock in a huge profit by hedging their next two years’ worth of production in the silver futures market. This makes all the economic sense in the world. However, when the price keeps on going up to $20, $25, $30, $35, they have to keep putting up more and more variation margin on their short futures position. Eventually, they run out of money and are forced to liquidate their position, going broke in the process.
I know that CRT’s basic emphasis is option arbitrage, but I’m curious, do you do any directional trading?
Yes, for my own account. I’ve always believed that technical trading would work. From time to time I dabbled in it, and in each case it worked very well. However, I didn’t like the way directional trading distracted me all the time. I turned my ideas over to CRT staff members who had both an interest in technical trading and the appropriate skills. They followed up by developing technical trading systems based on these concepts and assuming the responsibility for the daily trade executions. I rarely look at the system anymore, except for an occasional glance at the account statements.
How long has the system been operational?
Five years.
How has it done?
The system has been profitable in four of the five years it has traded, with an average annual gain of 40 percent for the period as a whole.
Did you do anything different in the losing year?
Ironically, it started out as a fantastic year. About halfway through the year, the system was really smoking, so we started increasing the position size very quickly. At one point, we must have nearly tripled it. That was the only time we increased trading size rapidly. As it turned out, if we had held the trading size constant, the system would have had a winning year.
Is there any human judgment involved in this system, or is it totally mechanical?
Early on, there was about a six-month period when human judgment was employed.
And it was usually detrimental?
Unbelievably detrimental.
It’s amazing how often that’s true.
Everyone says that.
What is your view of fundamental analysis versus technical analysis?
Back in the late I970s, I once gave a talk on technical analysis at a seminar. At lunch I ended up sitting at the same table as Richard Dennis. I asked him what percentage of his trading was technical and what percentage was fundamental. He answered with scorn in his voice, “I use zero percent fundamental information.” The way he answered, I was sorry I had asked the question. He continued, “I don’t know how you escape the argument that all fundamental information is already in the market.”
I asked, “How do you escape the argument that all the technical information is already in the market?”
He said, “I never thought of that.” I admired him for that. He had a humility about him that I think explains a lot of his success.
My basic argument was that there are a number of technicians trading with the same information and the distribution of success is a matter of who uses that information better. Why shouldn’t it be the same with fundamentals? Just because all the information is in the market doesn’t mean that one trader can’t use it better than the next guy.
To a major extent, CRT’s prominence is due to options. I assume that CRT is, in fact, the world’s largest trader of options. How did someone without any mathematical training—you were a philosophy major, as I recall—get involved in the highly quantitative world of options?
I have never had a course in math beyond high school algebra. In that sense, I am not a quant. However, I feel math in an intuitive way that many quants don’t seem to. When I think about pricing an option, I may not know calculus, but in my mind I can draw a picture of how you would price an option that looks exactly like the theoretical pricing models in the textbooks.
When did you first get involved in trading options?
I did a little dabbling with stock options back in 1975-76 on the Chicago Board of Options Exchange, but I didn’t stay with it. I first got involved with options in a serious way with the initiation of trading in futures options. By the way, in 1975 I crammed the Black-Scholes formula into a TI-52 hand-held calculator, which was capable of giving me one option price in about thirteen seconds, after I hand-inserted all the other variables. It was pretty crude, but in the land of the blind, I was the guy with one eye.
When the market was in its embryonic stage, were the options seriously mispriced, and was your basic strategy aimed at taking advantage of these mispricings?
Absolutely. I remember my first day in the T-bond futures options pit, when the market had been trading for only several months. Someone asked me to make a market in a back month. [The back months have considerably less liquidity than nearby months.] Since it was my first day, I felt really out of step. I was too embarrassed not to make a market. So I gave him a fifty-point bid/ask spread on a hundred-lot order. I said, “Look, this is my first day, and I don’t really trade the back months. I’m sorry, but this is the best I can do.”
His jaw dropped and he said, “You’re making a fifty-tick market on a hundred-lot!” He couldn’t believe anybody was making that tight of a market.
The bid/ask spreads were that wide back then?
Yes, there was far less volume than now. A fifty- or hundred-lot was considered a really large order.
Once you put on a position because the market provided you with a large edge for taking the other side, I assume that you tried to hedge the position to eliminate the risk. However, when you went to implement an offsetting position, didn’t you face the same problem of wide bid/ask spreads?
The first thing you would normally do is hedge the option position by taking an opposite position in the outright market, which had much broader volume. Then the job becomes one of whittling down positions that can bite you, and there are so many ways to do it. For example, if on the original trade I sold a call, I would now be looking to buy other calls and could afford to become the best bidder in the pit.
Obviously, in those early years, the option market was highly inefficient. It’s pretty easy to see how, in that type of situation, you could put on positions that were well out of line, hedge the risk, and make lots of money. However, I’m sure that with the dramatic growth in volume over the years, the market has become much more efficient, and those types of trades no longer exist. What kind of concepts can be used in today’s market to make money?
Yes, the market has become much more competitive, but so have we. As long as we stay a notch better than our competition, there will still be good profit opportunities.
So there are still mispricings in the market?
Absolutely. There will always be mispricings in the market. The notion that the market will trade at its precise theoretical fair value implies that someone will hold it there without getting paid. Why should anyone do that? The service of making a market, like any other labor, is one that people are not going to want to do for free, anymore than they would want to wait on tables for free. There’s work involved. There’s risk involved. The market has to pay someone to do it. It’s only a question of how much.
Is that payment a bid/ask spread?
Yes. If that edge did not exist, when someone walked in with a large buy or sell order, who would be there to take the other side?
The following section deals with theoretical questions related to options. Explanations for the layperson are provided within the bracketed portions of text.
What do you think are some of the conceptual flaws in standard option pricing models?
I don’t know how I can answer that question without disclosing information we don’t want to talk about.
Well, let me take the initiative. For example, is one of the flaws in the standard models that they don’t give enough probability weight to extreme price moves? In other words, actual price distributions have fatter tails than are implied by normal probability curves. Therefore, people using the standard models might then be inclined to sell out-of-the-money options at lower prices than would be war-ranted by the way markets really work.
Yes, that’s a flaw in the standard Black-Scholes model. When we first started, even our biggest competitors didn’t seem to have that figured out. and a lot of our profits came through that crack. By now, however, all the serious players have figured it out, and I assume that many commercially available models allow for it.
I would add, however, that it’s one thing to recognize that the tails are fatter than normal, and it’s another to know where to go from there. For example. do you simply fit your distribution to your empirical observations, and price options accordingly? That path has some serious problems. Do you take into account your hedging strategy? Are there other variables that none of the available models allow for? And, if there are, would their inclusion introduce so much complexity into the model as to make its application unweildly?
In other words, knowing that the distribution isn’t log-normal only opens a can of worms. Frankly, though, I still can’t understand why back then the competition hadn’t at least gotten the lid off the can.
Well, I think I can answer that for you. The standard mathematical curves that allow for specific probability statements just don’t look that way [i.e., don’t have fatter price tails].
I think that probably explains a lot of it, but it presupposes that reality matches the curve in a mathematician’s head. Believing that can get expensive.
Let me try another one. Standard option pricing models are price neutral—that is, they assume the most likely point is an unchanged price. Do your option pricing models differ by incorporating a trend bias?
They don’t, but I think some people believe that they do. There used to be a rumor that CRT gave this line about being price neutral and hedged but that we really made our money on direction. We didn’t try to dissuade people from believing that, because it made people more willing to trade with us. But now, since the cat is probably out of the bag anyway, I’ll confirm it. Our price models are neutral.
Hypothetically, let’s say that you developed a model that had a 60 percent probability of being right on the direction of the market. If you incorporated that trend projection, then your option pricing model would be skewed, and theoretically you could do better.
The obvious rejoinder to that question is that if you think there is a directional bias, set up a separate account to trade that idea, but in your option account, trade flat. You’ll get the same benefit, and if nothing else you’ll segregate the results due to each approach.
Do you believe that over the long run there’s an edge to being a seller of premium?
Not that I’m aware of.
Which do you consider a better predictor of future actual volatility: historical volatility or implied volatility? [Theoretical models employed to estimate an option’s value use a number of known inputs (e.g., current price of the underlying market, number of days until the option expiration) and one key unknown factor: the volatility of the market until expiration. Since this factor is unknown, all the standard option pricing models assume that the future volatility will be equal to the recent volatility. The option price indicated by this assumption is called the fair value. Some people assume that if the market price for the option is higher than the fair value, the option is overpriced, and if it is lower than the fair value, it is underpriced.
An alternative interpretation is that the market is simply assuming that volatility in the period remaining until the option’s expiration will be different from the recent past volatility, called the historical volatility. The volatility assumption embedded in the market price is called the implied volatility. If option prices are a better predictor of future volatility than is the recent past volatility, then the question of whether an option is overpriced or underpriced is not only irrelevant but actually misleading. In essence, the question posed above is equivalent to asking whether there is any reason to assume that the strategy of buying options priced below their fair value and selling those that are above their fair value has any merit.]
Implied volatility seems better to me. Conceptually or empirically?
To me it seems pretty obvious conceptually. The implied volatility is a statement of what all the players in the market, having cast their votes, believe is a fair price for future volatility. Historical volatility is nothing more than a number representing past volatility.
In the early days of option trading, however, when the markets were highly inefficient, did you use a strategy of buying options that were well below their historical volatility-based fair value and selling those that were well above their fair value?
No, we didn’t even do it back then. We never assumed that the historical volatility was a reliable guide to an option’s true value.
How, then, did you determine when an option was out of line?
By making a bid/ask spread where you believed you could find some other trade to lay off the volatility risk and still leave a profit margin. We were making judgments only about whether an option was overpriced or underpriced relative to other options, not about whether it was mispriced relative to the underlying market.
There’s been a lot of time and energy expended in developing improved option pricing models. If the model-derived price is not as good an indicator of an option’s true value as the current market price, does it really make all that much difference which theoretical model is used to derive option values?
I think it does. You still need the model to determine relative values. In other words, you’re trying to determine whether a given option is overpriced or underpriced relative to other options, not necessarily whether it’s underpriced or overpriced in any absolute sense. If two models have different opinions about the relative values of two options, then the people using those two models are going to trade with each other, and they can’t both he right. Yet neither trader may have an opinion about whether a given option is overpriced or underpriced, simply about whether it is overpriced or underpriced relative to other options.
Do you believe then that your ability to develop option pricing models that provide more accurate measurements of relative option values than do the standard option pricing models is part of the explanation behind CRT’s success?
The models are important, but the critical element is the people. To make a company this size work like a clock takes extremely unusual people.
During the interview, three other CRT employees—Gene Frost, Gus Pellizzi, and Niel Nielson—had entered the room and now begin to par-take in the conversation.
How does CRT differ in this respect from other trading companies?
GUS: People who have interviewed here have told me that what separates us from other companies is that the other firms appear to be solely interested in their technical competence—their education and experience. CRT, on the other hand, also tends to place a large emphasis on the person and how well that person will interrelate with the other people in the work group.
What kind of people does CRT look for?
GENE: In the earlier years, we placed some emphasis on hiring the brightest people. One person we hired was a world champion go player. He had a great mind. It was like putting a human computer in the pit. One day he made a bad trade, panicked, and couldn’t bring himself to cover the position and admit he had made a mistake. He waited until the end of the day and still didn’t get out. Luckily, Joe caught the error at night, but it still ended up costing us $100,000. Even though this fellow was brilliant, he had a character flaw that allowed the error to get out of hand. Whether this guy cracked because of some insecurity in not wanting to look bad, or because of some other reason, in the end it comes down to a character flaw. Joe has made the comment that he would rather have a good trader he could trust than a brilliant trader he couldn’t. When we hire people, we look for three things: character, character, and character.
Gus: I think we try to hire people who are less self-centered and more team players than is typical for this industry. A lot of other firms may also use these words, but I don’t think they are as integral a part of the company as they are at CRT. It doesn’t mean that we always get it right, but just trying seems to have put us ahead.
JOE: I would describe our people as those who take as much pleasure in the success of their group as they do in their individual success. We’re not looking for people who sacrifice their good for the good of someone else, but rather people who can take pleasure in the success of the group. People with this attitude enhance the value of everyone around them. When you put together people who are not worried about whether they, individually, are getting enough credit, you have a tremendous advantage over the competition.
How do you identify whether someone is doing a good job if many people are inputting into the final result?
JOE: You can tell. The people who work with the person know, and you can ask him and he’ll tell you. I recently spent some time reviewing an employee at CRT. He had written out pages of information showing what he was doing and an outline of his priorities. After about an hour of this, I finally said, “Look, how do you think you have been doing? How would you rate yourself? Not how busy have you been. Not how hard have you worked. But how have you really been doing?”
He thought for a minute and said, “Well, I think I should have been fired.” He proceeded to give me an honest evaluation, including his shortcomings. He knows how he’s doing, better than if I were looking over his shoulder, and he really wants to do the right thing. In general, if I trust someone to evaluate himself, he’ll do so and tend to be his own toughest critic.
Look, not everyone may have the right talents to do the job properly. Someone can come in here and sincerely say, “I love the idea of CRT and I want to be a team player,” but still lack the innate talent to do the job. Or a person might think he can do the job and find out later that he can’t. Maybe he’s not quick enough, or maybe he’s too emotional. That has to happen. How do you deal with that type of situation in an organization like this?
JOE: Just like you do anyplace else. But the difference is that if the person is not self-centered, it’s so much easier to find out that he’s not right for the job. He’ll admit it so much more quickly. When you get the right type of person, and he finds out that he can’t do the job, he’ll come to you.
Do the other people on the team sometimes come and say, “This person is just not working out”?
NIEL: Sure, that happens. But when it does, there’s a very strong effort to find a place somewhere else at CRT for that person. That has happened over and over again.
And does that work?
NIEL.: When we have a person whom we believe has the right type of attitude, it succeeds far more often than it doesn’t.
What distinguishes traders who succeed from those who fail?
JOE: Successful traders tend to be instinctive rather than overly analytical.
Why is being analytical detrimental to being a good trader?
JOE: Because it seems to mask intuitive traits and abilities. In fact, the most analytical people tend to be the worst traders.
What other traits distinguish the good traders?
JOE: Humility—the ability to admit when they’re wrong.
Doesn’t the fact that there’s more competition from other sophisticated firms doing the same type of trading strategies cut into your profit margins?
GUS: It has. The margins are a lot thinner than they used to be.
How do you handle that?
JOE: The margins go down, but the volume goes up. Also, in any business, the profit margin shrinks only up to a certain point. The margin can’t shrink so much that an efficient person in that business can’t put bread on the table. Therefore, if you can be the most efficient, there should always be a profit margin—maybe not all the time but certainly over the long run. I believe that’s true of virtually any business.
CRT is the preeminent firm of its type. What makes the company different?
JOE: At CRT we believe in the philosophy that people work best when they work for each other. People think that CRT’s success is due to some secret computer model. However, I believe that CRT has succeeded because we build teams. We try to give people a lot of authority and pay them what they’re worth. I’m often asked what is the reason for CRT’s success, and I’m willing to tell people because (A) they won’t believe me and (B) even if they did believe me, they couldn’t train themselves to do the same thing—to trust people and to give up absolute control.
Other people who do this type of trading often approach it too mechanically. People who are mathematically oriented believe that if you can just get the formula right, it solves the whole problem. It doesn’t. Most businesses tend to think that you work with one brain and a whole bunch of mechanical executioners. To build a machine that uses many different brains that are qualitatively contributing different things is an art. Most people don’t want to do it that way. Usually someone wants to believe that it’s his thinking that is making things run, and there doesn’t tend to be sufficient credit or responsibility given to other people. That’s not the way things work here.
For me, there’s a kind of magic around here, and I don’t know if that’s something you can pick up on or not. Without that, CRT would have been a much smaller trading company. We could have stayed in business and made a profit, but nothing compared to where we are now.
When you say “without that,” are you referring to the interrelationship among the people?
JOE: Yes, that’s the stuff that makes it a blast to come to work. I consider myself to be unbelievably lucky to be able to come to work in this kind of environment, with these people.
Joe Ritchie provides living proof that creative thinking can be more powerful than complex analysis. Although he has no formal mathematical training, by just thinking about how options should work Ritchie was able to develop an option pricing model that, judging by CRT’s performance, must be better than all the academically derived models commonly in use.
The type of trading done by CRT has little direct relevance to individual traders. The primary lessons to be drawn from this interview, I believe, are not related to trading, but rather management. The enormous financial success and widespread employee loyalty enjoyed by CRT is no doubt a consequence of Joe Ritchie’s managerial philosophy: Share the responsibility and share the profits. This policy makes so much common sense that you wonder why more companies don’t use it. Corporate America, are you listening?