My Story of Risk(tail)

I am lying on the floor of my office with my fingers lodged into my hair and wondering what is the right amount of force to apply so it would hurt like hell, but not result in bleeding.  The last bit reminds me that I am not completely crazy.  Not yet.

It is 2005 and I have a comfortable job running an IT group at a small consulting company in New Jersey.  I have a nice office with a view of trees, grass, birds, and other suburban awfulness.  The job pays very well, my daughter was just born and my son is turning 3.  In short, I think that I am dying a slow painful death.  I am so miserable, I want to scream obscenities at innocent bystanders.  Or rip my hair out.  Or whatever else one does to feel alive again.

So naturally, I decided to do something risky.  Why not  try my hand at trading derivatives?  And so I did.  I lost quite a bit of cash right away, which is the best thing that could ever happen to me.  There was a small chance that I could have made a lot of money (I was long out of the money calls), and had it happened, it would probably ruin me. Trading (options) was a great way to learn about myself, but that is another story.  Anyway, options trading was fun, but it was not enough.  Not even nearly enough.

In the end I left it all.  The job, the safety, the trees and the grass, my wife and my children, all my savings, and some of my sanity.  I think I kept my humanity.  You be the judge.  It all started when my wife and I moved to New York in 2007.  Then came my fascination with statistics, start up(s), divorce, misery, more misery, and redemption.  This is a story of risk through the eyes of one risk taker.  Have a seat.  It might get bumpy.

When we moved to New York, I was no longer working for the man.  I rented a small office on 28th and Broadway, joined a California startup (remotely), traded more actively, and took a couple of statistics classes.  To overcome the loneliness of solitary trading, I started New York Options Traders, a group that we run to this day.

After we had 200 or so members on meetup.com, Chris from the products group at International Securities Exchange, contacted me and offered to sponsor the group by providing meeting space, food and drinks, and occasional speakers.  I was shocked.  Why would real professionals want to waste their time with me and my tiny group?  (Thanks Chris and Mark – you helped more than you know)

The side effects of community building are just as rewarding as main effects.  I have met great friends and colleagues in the process.  Most of all, I was happy when people told me how much they liked our meetups.

While trading and interacting with other traders, I realized that the trading business is about managing uncertainty over the long run, not nailing individual trades.  I had some intuition for it, but I wanted to learn the subject more fully.  So on the recommendation of a good friend and Statistics professor Robert Stinerock, I enrolled in statistics department at Columbia and started dusting off my old calculus textbooks.  (Turns out this is completely unnecessary for trading, but that is also another story)

Columbia University is an interesting place.  I have met some of the smartest and some of the ‘not so smartest’ people there, and sometimes that would be the same person!  I had a passion for statistics, and I enjoyed taking classes.  I also liked the youthful feel of the place and I used it often as an escape from the daily routine and from my deteriorating marriage.

I ran into Alex in one of my classes.   He was working for Morgan Stanley at the time and was on the way to becoming a rock star exotics trader.  As I later found out, Alex had an offer to go to Moscow and help a senior trader build an exotics desk for the Russian Central Bank.  This job would have most likely made Alex some serious coin.  Alex never went to Moscow.  Instead he agreed to work with me.  This is how Risktail was born.

Meeting guys like Alex was the best part of going to Columbia.  Side effect turned out to be better than the main effect.  Go figure.

Risktail idea was to help options traders navigate the stormy waters of listed options.   When you buy a stock or a future, your position PnL goes up or down by a fixed amount in proportion to the size of your position (with no leverage, if the stock is up a dollar, your PnL is up a dollar).  It is for this reason that stocks are sometimes called linear instruments.  Not so with options.  For a dollar rise in the underlying stock, your PnL may go up 10 or down 0.50.  The next increment can result in down 20, and so on.  In this sense, options have non-linear payoffs despite the sophomoric hockey stick diagrams.  This non-linearity gives options all the interesting, albeit unexpected properties.

My idea derived from personal experience and running NYOT,  was that instead of relying on the model heavy analysis of options portfolios, we would let the analyst run through historical options prices subject to specified constraints and thereby provide a real feel for the evolution of the portfolio.  This is called backtesting, and as it turns out, options backtesting is a really hard problem.

Complex analytics require some careful architectural consideration.  A more rigorous design process would have revealed the complexity of the problem and would have helped reduce the scope of the initial product. We particularly underestimated the amount of effort required to obtain and clean options data.

Alex and I started working in the statistics lounge on the 9th floor of the Columbia’s SSW building.  At that point, I left the California start-up and instead started focusing full time on Risktail.  Alex developed a basic prototype and I got us a demo with an up and coming retail options brokerage firm (Thanks Aric.  To this day I believe that if we had a working system, you would have worked with us.)  The demo went great and we got a lot of encouragement, so naturally I felt that we were onto something.  In retrospect we might have had something, but the optimism was premature.

Despite what it I originally thought, most people wanted us to succeed.  Turns out, when I was passionate about the project, people generally gave me the benefit of the doubt and went along with my story, and encouraged me to continue.

In the winter of 2010 while reading Fred Wilson’s blog, I found out about the NYCSeed start-up accelerator program run by Owen Davis and immediately applied.   In the spring, we were invited to present to the program mentors in the New York office of DogPatch Labs, which is run by the wonderful Peter Flint.  In a separate email, I notified Owen that I was recently served the divorce papers and felt that even though I could manage it while building Risktail (I was wrong), it was an important enough event that I needed to disclose it.

Most of my friends told me I should not disclose this.  They will not work with you, many of them said.  I said bullshit.  If they don’t want to work with me because of this, fine; but they still need to know.  

We continued building the product and in April we received a form letter from Owen that we did not make the cut.  Not deterred, we continued building.  Then sometime in July, when I was sitting in Uris Hall in the Columbia’s Business School Library, my cell phone rang.

“Hello, is this Eric?”

“Yes”

“This is Owen Davis”

“hmmm, Hello”

“I was wondering were you guys are with Risktail?”

“Still building. Had a few early demos with potential customers.”

“Would you be interested in joining NYCSeed this summer?”

I swallowed hard.  I knew that Owen’s group would bring us the type of experience, opportunities, and connections, that would be hard to obtain on our own.  This was potentially life changing.  Not wanting to sound like a wimp, I said:

“Let me talk it over with my co-founder.  I will get back to you tomorrow.”

“Sure thing”.  Click.

I called Alex.  He almost fell off whatever he was sitting on.  I believe his response was something along the lines of “Fawk Yeaaah….”

But there was a little problem.  My funds were rapidly deteriorating.  I had no other source of income and my divorce was escalating.  I was considering taking a side consulting gig.  $20,000 gift from NYCSeed would not be enough to sustain me, my family, and Alex. (It was not really a gift; it paid for 5% common in Risktail and implicit follow on rights if desired, but given the expected value, this was a far out of the money call option; sort of like my first trade and turned out to be just as successful.)

So without thinking about it much, Alex, who still had some of the Morgan Stanley money, immediately offered to lend me the contents of his bank account.  Floored by his generosity, and afraid of all possible repercussions (he is Russian, you know), I hesitated.  We talked it over while taking a walk up 5th avenue near Columbus circle and sipping on iced tea.  It was a hot summer day.

“Dude, we should definitely do this”, said Alex.

“I don’t know man.  I mean, I appreciate all the help, but this is a lot of money”

“No worries. We will make it back.”

I think he felt that this was his shot at greatness as well, and he did not want to pass it up.  He also knew that I would make it right one way or the other.  Hesitant, but optimistic, I decided to take the plunge.  And so, stage 2 of our project had begun.

NYCSeed secured office space at NYU business school and four other companies joined us there.  The schedule was packed with mentor meetings, dinners, legal presentations, and other things that I no longer remember.  But all I kept thinking was how am I going to close the first deal, the first beta, the first anything.

Matt Gorin from Contour Venture Partners, who was our primary mentor, kept pushing us to come up with the stronger value proposition, the secret sauce, in the VC parlance.  I too felt that the product was missing something, but I couldn’t quite put my finger on it.  I decided to call Tom Sosnoff, who was still running Thinkorswim at the time.  When I showed him the app, he was not impressed.  Nice, but get back to me when it works.  Thats what it was missing.  It did not work!

This should have been a big clue for us.  We (Alex and Luka, our Serbian genius coder) spent over 6 months of intense coding on the product that still did not work.  A small team with limited resources can not afford not having something out in front of the customers in 6 months.  The corollary was that that the product was too big for our team and for our resources (i.e. too many features that I mistakenly thought we desperately needed.) 

When we started, my intent was to sell to retail brokers thinking that it is the shortest path to customers.  My experience in B2B told me that if I nurture few early enterprise accounts, they will take me from concept to product and pay for it.  But retail brokers are not your typical enterprise customer in a sense that their key products are NOT facing their internal users who are used to being abused by awful software.  Their users are retail traders who are accustomed to beautiful software that works almost without a hitch.  It was unreasonable for me to think that they would take an alpha version, not matter how much they liked us.

In fairness, Roger Ehrenberg from IA Ventures told us early on that selling to retail brokers is a giant pain in the arse.  He was not giving us a typical VC blurb from 30,000 feet.  Roger did a few deals in the space and had some experience in that market.  Stubborn as I was, I ignored his advice and we kept working the feature set.

By the time the demo day rolled around we had a few more leads and expressed interest from another large retail brokerage, but still no working product.  We wanted to raise a $700K Seed round, but the reception was lukewarm.  Show us some traction was the most common response.  This should have been a clue also.  At seed stage, it is possible to raise a round without a ton of traction (it is hard, but possible, and traction does not have to be measured in $$).  What a lot of them were saying was that they did not believe this was a compelling opportunity and there were no signs of market demand.  I hate to say it, but they were right. (Yes, VCs can be right sometimes.)

In retrospect, we were going into a very crowded space and not disrupting it!  Existing retail brokers would have all the leverage, even if we built something truly remarkable.

By the time I was busy running around New York meeting with potential investors, my divorce was heading for trial and I had fired my attorneys.  I missed one month of temporary support payments to my wife and was facing possible jail time for contempt of court.  Emotionally, I started to lose it.  I remember standing in front of the judge and being told that it was in my best interest to hire a lawyer.  I had no money left to do that.  I could not even pay my previous lawyers legal bill.  I walked out of the courthouse, looked up at the sky, and for the first time saw complete darkness all around.  It was high noon and sunny … I think.

We did not raise the Seed round.  The sad thing is that one of our potential clients agreed to pay us to complete the product.  It would not be a lot, but had we gotten it earlier, we might have taken it.  At this point, both of my co-founders worked without pay for almost a year.  The gig was up.  It was too little too late.  We threw in the towel.  I threw in the towel.

Hindsight is 20-20 as they say.  I believe that first and foremost my mistake was strategic.  In particular, we should not have chosen to pursue the indirect sales channel, given our very limited resources.  Even if we were able to get installed, we still would not know if we had a viable business, as we had no access to price tolerance data and our ability to scale beyond a few initial customers was largely unknown.  Instead, we should have focused on building a small strategy tester for one asset class, nailed it, and went direct.  We still might have missed, but at least we would have gotten a more diversified feedback from actual users.

I know now that focusing on a sales channel from day one is a mistake.  You are once removed from the end user.  And once is too many in this case.

In the end we failed and failed slow.ly, but it was not for the lack of trying.  Guys who worked with me on this gave it all, and then some.  Luka, who is currently a lead developer at Real Direct created our beautiful front end without knowing anything about UX and Adobe Flex.  Alex did not know Python when he started and built a super fast analytics engine.  Mladen, our statistician in residence, spent many hours coaching us what the data presentation should look like, and was the only one who was always telling me that I didn’t know what the fawk I was doing.  Boy, was he right. Thanks, dude, I needed that!

Overall, the experience was transformational and in a sense life changing.  If I have any regrets, it is only that I have not delivered for my team, for our mentors and investors, and for our families who had not seen much of us as a result.  All the glory belongs to them; the mistakes are mine, and mine alone.

Even though I came out bruised, I am not deterred.  Now more than ever, I am optimistic about the rate at which technology is transforming industries from education, to government, and yes to finance.  Once again, I am starting to write down ideas, and I am looking up in the sky.  It is so bright outside; I may need sunglasses.  It is now close to midnight.  I am ready to work.