An Interview with Joe Corona, Tony Saliba's Head Trader

I've twice gotten the chance to watch Joe Corona in action as he runs the day-to-day trading operations at Tony Saliba's firm. Joe is a 20+ year veteran of the markets who plays this game intensely but also very conservatively. Tony Saliba has a reputation of being a low-risk options trader and Joe impeccably executes this low-risk approach. But, when you watch him in action, you can very much see the ex-college football player in him. When you're 6'6", weigh ... (never mind, he'll kill me), and are as animated as Joe is, it's quite an exciting and memorable event to watch him do his business.

I got the chance to interview Joe earlier in this month. He's the first options trader we've interviewed for this column and there is a good reason for this. I hope you enjoy and profit from our discussion.

Larry Connors: Joe, how did you get started in the business?

Joe Corona: By accident, actually -- I have a teaching degree. While I was looking for teaching jobs, in order to make a little money, a friend of mine got me a job as a runner on the CBOE.

Connors: This was after you came out of Northwestern?

Corona: Yes.

Connors: You played football for Northwestern, is that right?

Corona: Yes, I graduated and then I was on the floor of the CBOE. I had no interest in the business at all. I was just down there to make a little bit of money while I was looking for a teaching job. As I was there, I began to figure out what was going on, had a look at the business and the people in the business and decided, "I can do this just as well as they can." So I decided to stick around.

I went from a runner, to a phone clerk, to a broker assistant, to a trader. I didn't want to be a broker so I hooked up with some market makers as an assistant. Later on, I got some backing as an arbitrage trader where I traded options on the floor of the CBOE, arbitraging options vs. the stocks. So that was really my first trading job, I think it was 1982. I was an arbitrage trader for a New York firm.

Connors: And from there?

Corona: From there, I stayed on the floor of the CBOE oh, until 1984, and at that point they introduced options on Treasury Bond futures at the Chicago Board of Trade, I'm not sure exactly when those were introduced, maybe 1982 or 1983, and they were beginning to pick up.

I was kind of dissatisfied with my situation on the CBOE so I hooked up with a guy who was looking for people on the Board of Trade to trade the bond options and I went down there and started to trade bonds. I traded those in that small partnership through 1985 and later on, we cut a deal with a clearing firm to start an operation where we could bring in traders, train traders, manage the risk and basically form a floor-wide trading group. So we started to deploy traders on the futures options pit on the Chicago Board of Trade and this went on through 1986 and then we got memberships on the Chicago Mercantile Exchange and did the same over there.

Connors: And from there you joined Tony Saliba?

Corona: No, I've been associated with Tony for a long time in kind of an arm's length way. In or around the early 1990s, Tony started his school where they would train traders, bring in teams from overseas or domestically -- mostly bank people -- and train them to run a book: how to make markets in options, how to manage the risk in the positions they accumulated, and how to modify the risk and basically detoxify the positions they were carrying, and so on.

I've known Tony from the floor because when I was on the CBOE, I traded in his pit, Teledyne and Johnson & Johnson, quite a bit. Back in 1982, 1983 and 1984 when I was on the floor of the CBOE. I can't recall how we hooked up but I came on board as a teacher from time to time. I would teach his courses, training people how to manage a market-making business, basically, from a banker's standpoint. I taught for Tony quite a bit all through the 1990s but I wasn't really associated with him in any sort of trading sense. I still ran my own trading businesses. I worked in my own jobs during that time. I didn't officially become a partner with Tony in trading until May of 2000.

Connors: You just launched a hedge fund, correct?

Corona: Yes, we launched it. Our first day will be Friday (Feb. 8, 2003. Note: This interview was conducted on Feb. 4). I've just been working on that for the past few months -- we've been jumping through all the legal hoops, all the marketing hoops and all the regulatory stuff. There's a lot of interest because it's one of the few funds that uses options pretty actively.

Connors: Why do you predominantly use options as opposed to the underlying?

Corona: Well, we're going to use them in combination, and I think that's probably one of the most powerful ways you can use it. It’s a situation where we are going to use the options to modify risk on our underlying portfolio. We are going to have a core portfolio, more or less like the Dow and S&P, but we are going to modify the exposure of the portfolio by using the options.

Connors: What would make you go long or short the Dow or the S&P. Do you use specific models?

Corona: We have a strategy which is going to have exposure to the market. It will have a delta between zero and one in terms of market exposure. It’s never going to be short. It’s going to be a strategy that’s going to be geared for a sideways to choppy market and maybe a slightly higher market. We did that on purpose because that’s the kind of market we think we’re going to have for the next couple of years.

And then we’re going to then take the portfolio and we’re going to have different sectors weighted different ways: Some will be overweighted, some will be underweighted, some will be neutral. And we’re going to modify the exposure to the market based on the location of the options, what strike we use, what month we use, and things like that. And we are also going to trade it and use the timing systems that I’ve been using over the years to signal when we need to modify the exposure to the different components of the portfolio.

Connors: So let’s take the S&Ps, for example, and play it out. How does it work?

Corona: Well, for example, let’s say that I got a buy signal on the S&Ps; our fundamental research was neutral on the S&P as a whole and for whatever reason, I got a buy signal which indicated that we want to be exposed to the S&P. We would then take our volatility and option research and we would locate which were the cheapest options and which were the most expensive and we would go in and we would buy S&Ps and we would purchase some puts and the strike of the puts that we purchased and the expiration date of the puts that we purchased would depend on our volatility research -- what we deemed to be the relatively cheapest put for the position.

Connors: So is it essentially buying insurance off the position?

Corona: The positions will have downside limited risk at all times, meaning when we are long stocks, we’re always going to have a protective put in place. What’s going to change is which put it is and where it’s located – it could be a short-dated put that’s fairly close to the money, depending on what we think of the market and basically what’s the market’s giving us. It could be a longer-dated put and farther away from the money, depending on how we view the stock.

And we will almost always – not always, but almost always -- be short and upside down the money call. So basically, if you take these positions together, they become a vertical spread and a diagonal spread, synthetically, so it’s a limited risk vehicle – limited risk to the downside and limited return to the upside -- that’s going to be constantly modified and constantly manipulated and traded against.

Connors: And the goal is to make a small amount of money every month?

Corona: Yeah. If we can come out ahead 2% a month, I would consider that fantastic. You know, in the beginning, it’s going to be very conservative and I’m not going to be trading it that actively. A chess match is what this hedge fund is going to be. So we’re just going to take what the market gives us; we’re going to be analyzing the underlying, in and of itself, both fundamentally and technically, and also we’re going to be analyzing constantly the options on those underlyings, looking for novel ways that we can exploit it.

Our edge is the fact that we’ve got very strict volatility analysis; we’ve got very powerful technical analysis; and our execution systems allow us to execute probably in the mid price rather than trying to offer at a bid in the options market.

Connors: You mention your technical or market-timing analysis is superior – what are the components behind that -- how does that work?

Corona: Well, I mean a lot of them are fairly simple. There are a group of them and the more they agree, the more powerful the signal is. A lot of them can be as simple as standard deviation bands, simple overbought and oversold indicators. A lot of it has to do with mean-reversion type of analysis. As you probably know, I am a big fan and a big user of the Market Profile.

Connors: For the people who don’t know what that is, what is Market Profile?

Corona: Market Profile is a form of technical analysis that was introduced by Peter Steidlmayer on the Chicago Board of Trade; they used to call it the liquidity data bank. People who worked on the Board of Trade in the mid-80s are really familiar with it and maybe other people. It’s a form of technical analysis where each time period is assigned a letter and the market is broken down into time periods.

Connors: What other strategies do you use for market timing?

Corona: I look at volatility quite a bit, as you know.

Connors: The VIX, or volatility itself?

Corona: I look at the base level of the VIX, the VXN…and I also look at the shape of the skews of the major indices – the steepness of the slope of the S&P options and the OEX options to try to get an indicator of market psychology.

Connors: The steeper the slope, the more…

Corona: The steeper the slope, the more scared people are and the greater the chance that you are nearing some sort of climax…so for example, if I had a base position on and the skew got really sharp, it got really steep to where it was within 90% of its historical high, I would look to make modifications to the position such as selling the puts that we hold and buying puts at a much lower strike, to modify the positions.

Connors: You basically never make directional bets if you’re hedged at all times.

Corona: We're hedged at all times. The first strategy that we’re launching is a bull strategy, very mildly, a very passive bull strategy but the difference between a mildly bullish strategy and letting it run by itself is that we are making constant modifications that we think can add additional return, you know, by manipulating the options, by basically swing trading it and making adjustments when we get signals, we think that our strategy not only will perform well in a bullish environment – which we may or may not see this year, you know I’m kind of skeptical about this myself – it also should perform fairly well in a choppy environment which I think we are more likely to see this year.

Basically, the great thing about options and the reason Tony and I like to use options is that you can constantly turn them into something different as your opinion changes. You know, I can turn calls into puts; I can turn puts into calls depending on how I apply underlying positions; I can turn them into spreads.

That’s what’s really appealing to us is that we like to play chess with the positions. You know, figure out... if we are going to have a core position on a portfolio of stocks, protecting them with puts, researching which is the optimum put to use as a protection and also which is the optimum call to sell against it. So we’re constantly looking for the most expensive and the most overpriced calls to sell against our portfolio, we’re looking for the most inexpensive puts to own. Then as the markets change, we’ll change the insurance.

Connors: For someone who doesn’t know how to do that – to find the most expensive or least expensive calls and puts, could you just briefly go over that for someone wanting to get involved in options?

Corona: Here’s what I’d do: I would start out by reading Tony Saliba’s book,"The Options Workbook," then Sheldon Natenberg’s book, “Option Volatility And Pricing,” and I would also read Nassim Nicholas Taleb’s book, “Dynamic Hedging: Managing Vanilla and Exotic Options.” Then I think what you need to do is look at a site like http://www.IVolatility.com where you can see historical distributions, volatility and historical highs and lows of volatility over different terms and try to get an idea of -- just like the market, cheapness and richness are all relative — things can always make new lows, things can always make new highs. Just because something gets near an old low doesn’t mean it’s going to hold.

So, get an idea of the types of fluctuations that take place with options in different time frames. What’s the historical range of volatility of a 30-day option? What’s the historical range of volatility of a 60, a 90, a 120? What are the historical fluctuations of LEAPs? Just so you can kind of get an idea of how the things move, under what conditions. And like anything else, especially with options, I would say that observing for a long period of time is always beneficial. All in all, like any other form of analysis, it’s just long periods of observation and measurement. The best thing you can do is read about it and try to get an idea of what option volatility is and what it’s telling you and then go back and look at some historical data and see how it behaves.

Connors: Joe, you and I have had this discussion before about the put/call ratio. Can you give us your thoughts on that?

Corona: Let me explain why I think it’s useless. Puts can be turned into calls, calls can be turned into puts. How many actual puts are trading and how many actual calls are trading means nothing because let’s say I’m a big hedge fund. In my hedge fund, I get a buy signal on XYZ which is in my portfolio and I do my volatility research and I decide that the 30-day puts are cheap. Maybe at this time I’m looking for a pretty nice move so I don’t want to sell the call right away. So I go ahead and I buy 100,000 shares of XYZ stock and I go in and buy 1,000 puts. OK, well that shows up as a purchase of 1,000 puts which would, according to conventional wisdom, be an indication of fear or someone thinking the market is going down. Well, in actuality, what I’ve done by buying the stock and buying the puts is constructed 1,000 calls. So the puts show up as a bearish bet when in actuality there was a bullish bet made.

As a trader, I must tell you that the times we used to get most concerned about the market rallying was when there was active buying of puts, not because of the fear but because we knew that the house was probably buying stock and puts at the same time. We were looking at it as bullish because people were buying puts against stocks -- because they thought it was going up. That’s how it could work. The bottom line is that I think that indicator is useless. If there was an object that had no underlying – which there isn’t, and there never will be because there has to be – if we were only options trading then it might be worth something. But as long as the underlying can come into play and you can construct synthetic positions, I don’t think that indicator is worth anything.

Connors: Joe, if I put a gun to your head and said, “Is there any one thing in technical analysis that you like the best?” What would it be?

Corona: Market Profile.

Connors: What would be second?

Corona: Volatility. Look at the VIX, VXN and also the shape of the skews.

Connors: I know you and I discussed this a year ago, but to put what you are saying into a specific example, let’s say, the OEX for argument’s sake was trading at 400. We would take a look at the 425 calls and the 375 puts.

Corona: Yeah, take the volatility of the 375 puts and subtract the volatility of the 425 calls and find out what that slope is.

Connors: We were also looking at price. When the puts get excessively priced over what the calls are priced…

Corona: Well that would be another way to identify an excessive slope. You can look at volatility vs. volatility or you can look at price vs. price. I mean the volatility is what generates the price. Either way you want to look at it.

Connors: Goldman Sachs did a study – you and I talked about this a year ago – they released a study that shows that when the prices get to be out of whack, it’s a pretty good indicator that the market is going to reverse.

Corona: Yes, you saw that in October. The slope got pretty high up there, very, very steep… The puts got way over the calls.

Connors: And that basically told you that a rally was likely near?

Corona: Yes. Now naturally, just like with the VIX, that occurs when things are the scariest so it takes some noogies to go in and fade that. But again, you can make limited-risk bets that take advantage of that

Connors: How do you make limited-risk bets on those things?

Corona: What I would do in that kind of situation, I might construct a diagonal spread where I would buy an at-the-money option which doesn’t have high volatility, maybe, if you got a signal like that – extreme steep slope which usually indicates the market will have a violent reversal soon…

Connors: So you’d buy an at-the-money call…

Corona: You might buy an at-the-money call and sell a far out-of-the-money longer dated call against it, you know, get into a diagonal spread.

Connors: So you’re doing a further-out calendar and price spread?

Corona: Yes, what you’re doing is buying an at-the-money short-dated option, say an at-the-money 30-day option, OK, which would be the lowest point of the volatility curve, and maybe you’d sell a further out of the money call…

Connors: How much further?

Corona: It depends, you’ve got to kind of make a guess and this is where technical analysis comes in. You have to look at charts where you think the nearest significant resistance is and that’s where I usually like to plant my short.

Connors: And date-wise, would you go 60 days, or would you go longer?

Corona: Well, first of all, what option I would buy and what option I would sell would be determined by the conditions at the time. I’m just talking hypothetical here. I mean obviously, if a near-term option was ridiculously priced, I wouldn’t do that but I would go look for what option I thought gave me the best edge, and then what location gave me the best edge, and that’s how I would construct that.

Connors: Would 60 and 90 days be pretty typical, though?

Corona: Something like that. You have to see how things react to the sell off. If you have a very sharp sell off, short-dated options reflect short-term activity, whereas longer dated options reflect longer-term trends, so a lot of times you get a quick spike down and all the short-dated options, you know, the 30, 60, 90s and so on, might have a sharp spike up. The LEAPs might not even more. You know, in that situation, you might buy yourself a LEAP call and sell yourself some inflated short 30, 60, 90-day calls, against it, maybe 10% higher or something like that.

Connors: So the volatility on the 30-day at-the-money call would collapse worse than…

Corona: Well, here’s the kicker. Let’s say you’re in a situation where the market’s been moving sharply, volatility’s jacked up, the skew is jacked up, the slope’s jacked up. When you go in and you buy an at-the-money short-dated option, you are paying through the nose. But the market has been yielding a certain amount of movement. If you get the rally you’re looking at, that call is going to become deep in the money so fast -- if you’re right -- that it won’t lose any volatility. I mean it’s going to shoot right up that slope. If the market rallies, that call is going to turn into the stock very quickly and also the volatility of that call is going to rise very quickly as it becomes deep in the money.

A deep in the money call becomes an out of the money put, in volatility terms. So what will happen if you do something like that, you’re looking for a move higher and you’re looking for a collapse in volatility. You want to have something that has a negative vega exposure or a short volatility exposure but yet a positive gamma exposure. So you like a situation where you buy some short dated at the money options like a call if you think the market’s going to go higher and you sell longer dated out of the money call against it and then if the market does shoot higher, the at the money call that you purchased, the short dated one, drops in the money. It gives you some serious fire power, and then as volatility collapses, the short vega position generated by the longer-dated call that you’re short, you know, causes that call to collapse in relative terms. You’ve got a short-dated call sliding down the skew and volatility coming down and its relative volatility going up.

Connors: We are doing this interview on February 4. As it stands right now, it looks as if they’re going to go to war with Iraq. If history proves itself correct, we’ll probably see a spike in volatility when that happens?

Corona: Yeah, I mean you’ve probably seen it now.

Connors: And where will you be at that time, when war gets launched. We are seeing a spike in volatility now but let’s just assume it spikes even further. Will you be a seller of volatility at that time? Is that where you’re going to be looking to make your money?

Corona: Yes. I’ll be selling volatility. Based on the way volatility is shaping right now, the market is looking for this to occur – I think they might be wrong -- but it looks like some time between February expiration and March expiration. The March options are very well bid relative to the April options which are the next earnings options. Normally, April options have a higher volatility than the March options because they cover the next earnings period. That’s inverted because of this war fear, so when the war actually starts or it looks like war is imminent, and I’ve been here since the last one so I know how these things are going to unfold -- I think this one might be a little different -- I will probably be looking to sell March call options, buy stock and buy April put options. If the market’s giving me that.

Connors: So you’ll sell March call options and buy April put options.

Corona: Given the way that it’s shaped right now, I’ll probably buy April or even longer-dated put options against long stock and sell March call options.

Connors: I would assume on a volatility basis, because of the earnings coming out, your May options would be a little cheaper, volatility wise?

Corona: Yes, they should be. Depending on what stock it is and so on, but in general, yes, you see a declining slope. And what you’re seeing right now is a really nice – if you were to graph the volatility of the at-the-money option over time – you’ll see a really nice hump right around the March expiration period, the March cycle, and gradually declining into the summer, which is normal. But usually that hump is located in April so you’ve got kind of a goofy anomaly going on here. Everybody and their brother is looking for a rally once this war starts and that’s what I think might be the hook.

Connors: You know, I remember having a conversation with Tony after 9/11 and it was probably about six or seven weeks later, you know, it was more of a friendly call to make sure everything was OK because we were hearing some wild stories. You want to make sure that everyone is all right. Tony said it was Christmas time for you guys. You were buying up volatility throughout the summer, and then 9/11 comes and volatility goes through the roof and you wind up selling it to the people who you were buying it from. And doing more selling in anticipation of buying it back from them as it collapsed. And that’s essentially your game, you’re looking to…

Corona: I mean really, especially in my trading in general, it’s a game of patience. You’re really waiting for people to get off base before you throw the ball.

Connors: Your timing’s never perfect, but it seems like…

Corona: I know. We got pretty lucky with that too. Before the terrorist attack, the volatility actually got mutilated in August. I mean where I think the VIX got down to 18 or 19. And also, technically, you had these very ascending wedge patterns and a very narrow range, extremely low volume, choppy higher highs. I mean it couldn’t have been a better setup. So the volatility expansion and decline in the market started well before the terrorist attacks. I mean that was just the icing on the cake. We were short based on the technical patterns and also the fact that volatility had gotten punished down to low levels, so we were long vol and short the market and then… you know, we had already started scaling out of some of our positions and then the terrorist attacks came and the first day we opened after that, I got out of everything because I was worried about government intervention and so on. But we got lucky on that one. Basically, that’s how the game works.

Connors: It seems like you guys get “lucky” a few times a year doing this, and with some substantial rewards.

Corona: Oh I think if you’re patient, the market gives you a couple of opportunities a year, volatility wise.

Connors: Joe, it almost sounds like you guys channel-trade volatility.

Corona: Yeah, you could say that. Well, because of the way volatility is. It’s mean-reverting, so it has to stay in a channel, by definition -- although different areas of the channel have different widths. So, that’s basically what it is. We monitor volatility and we will be buyers near the lows and sellers near the highs or we’ll be constructing structures that, you know, are long or short near the lows or near the highs, but when we get low or high volatility conditions with the appropriate technical signals, that’s when we really put the hammer down.

Connors: Joe, thanks very much, this has been great.

Corona: Thanks Larry.