Option Investor
Trader's Corner

Thankfulness

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While we're counting blessings this week, we options traders should perhaps spare a few minutes in quiet thankfulness to a guy named Joseph Sullivan.

To understand the role he played in our lives as options traders, visualize going back in time to a day before April 26, 1973. Imagine you believed that one of the stocks in your portfolio might decline over the next few months, but you didn't want to close your position. You wanted to protect your long stock holding by buying a put.

How did you accomplish that task? You certainly didn't do it by logging onto the site of your online broker. You called or visited your traditional broker, of course, but the process could not be completed with that call alone. Your broker then called his trading desk, and someone there contacted a put-and-call broker or maybe several if you wanted more than one quote. In the early 1970s, about 12 or so such firms existed, from the largest firms employing 20-25 down to the smallest employing maybe a couple of people. Each put-and-call broker contacted gave your brokerage's trading desk a quote, and that trading desk contacted your broker, who then contacted you again.

Not only was the process a convoluted one that would drive contemporary options traders mad, but also that quote wasn't even a standardized one. It wasn't for a standardized time period. At one time, if it was to be exercised, it had to be exercised in person. If it wasn't, it expired worthless, no matter how deep in the money it might be. The put-and-call broker had no limit on the spread between bid and ask. The put-and-call broker decided on a price based on his experience with the stock.

This was strictly an over-the-counter business with a low annual volume in options, with the buyer of the option left unclear as to whether the price paid had been a good or bad one. Perhaps we should add Fischer Black and Myron Scholes, the Nobel-prize winning creators of the Black-Scholes option pricing model, to that list of people to whom we're thankful.

The U.S.'s first options exchange was the Chicago Board Options Exchange, the CBOE. Trading on standardized, exchange-listed options began at 10:15 CST one Thursday morning in a windowless room variously described as the former lunch room or former smoking lounge of the Board of Trade.

The idea for the exchange had been born among Chicago Board of Trade's grain futures traders, so we can add those futures traders to the list of people to thank. We should also be grateful to the weather for waiting until 1972 and 1973 to create such a scarcity in grains that the Board of Trade saw record volume. The idea for the CBOE arose in the years immediately preceding that record volume, when Joe Sullivan, former reporter for the WSJ and then assistant to Chicago Board of Trade president Henry Wilson, started asking those put-and-call dealers questions. Business at the Board of Trade had been slow before that scarcity and the CBOT thought listed stock options might increase business. If that record volume had come along sooner, the idea might never have been born.

The CBOE's first day of trading saw options traded on 16 underlying stocks, with a total of 911 contracts traded. Joe Sullivan was tapped as the first president of the exchange. It was Sullivan who campaigned for standardizing options pricing and expirations, and who also wanted a separate entity, a clearing house, to guarantee settlement and performance and to issue contracts. Members on the CBOE paid $10,000 for a seat, although rumor has it that some paid only $100 for an option for a seat on the exchange and some had their option fees paid by founding members who grabbed them and urged them to go sign up. Some of the first members came from the put-and-call dealers, but also from other areas of the over-the-counter business in New York.

Sullivan worried that the exchange would flop, and trading did get off to a slow start, averaging around 1000 contracts a day. By the end of the first year, however, volume was 40 times higher than it had been in the beginning. None of that volume came from puts, however. Puts did not start trading on the CBOE until 1977, when the SEC finally allowed them to begin trading. The SEC had delayed their introduction all that time.

The SEC wasn't through with the fledging exchange or the other exchanges that had decided to trade listed options since 1973. In 1977, when listed puts began trading, those included the American Stock Exchange (AMEX) and the Philadelphia Stock Exchange (PHLX), both beginning to trade listed options in 1975, and the Pacific Exchange (PCX), trading listed options beginning in 1976.

After some wrangling between the CBOE and the AMEX, the SEC allowed the first multiple listing of a stock's options on more than one exchange, with Boise Cascade's options the first to be listed on two exchanges. It wasn't long after that multiple listing or the approval to trade puts that the SEC put a moratorium on additional listings.

That moratorium was to last until 1980. The SEC's regulators were still wincing over the discovery that it had not detected ongoing fraud at one of the exchanges and had been politically empowered to do a better job. They took their time studying listed options. According to some, the unfamiliarity of many regulators with options trading also slowed the process. Regulators studied whether there was unfair competition among the exchanges, among other issues. During those years between 1977 and 1980, other political changes and a greater understanding of the options market, among other reasons, gradually worked toward a lifting of the moratorium.

After that, options trading took off, with many changes. The exchanges added index options, the Options Clearing Corporation evolved its clearing operations, new exchanges jumped on board, and the totally electronic International Securities Exchange (ISE) pressured the other exchanges to change the way they did business, even before it was fully operational. Exchanges settled with the Justice Department and SEC over allegations that they were blocking competition, so that now we have many options listed on multiple exchanges. Exchanges linked with each other, and many other changes occurred that benefited traders.

Along the way to moving into this new electronic and linked world, the exchanges weathered the bloodbath of the crash of 1987, when computers figuring the options prices could not handle the day's traffic and "spit out garbage," according to Jim Porter of First Call, as reported in an article in 2003 SFO MAGAZINE. No closing prices could be given for options prices on all the new series that were required on the day of the crash, and First Call provided the Options Clearing Corporation with closing prices for days, using theoretical prices.

Jim Porter and others at First Call should probably be added to our list of those we options traders should thank, along with all the other multitude of people who had vision and persistence enough to make our trading lives possible.

And to my personal list of people to whom thanks are owed, I add Jim Brown, who structured his OptionInvestor website to provide information in his "teach a man to fish" philosophy. Along the way, he recruited a subscriber to write for the website, representing the self-taught options trader. I was that subscriber. Thanks, Jim.
 

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