Reminisces of a Equity Option Trader

Henry Jennings

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This week marks a seminal week in my life. 30 years has slid by in the blink of an eye and tomorrow I will gather with fellow survivors of the 87 crash to celebrate those days.

I started as a back-office clerk in the UK before becoming a trainee dealer on the floor of the London Stock Exchange. I soon found out that I was pretty good at it and loved the market. I rode the changes rort by Thatcher in the early 80s and the Big Bang in the city to become a member of the London Stock Exchange in 1985. Two years before the crash. I had been in the market for 8 years before that fateful October.

I had moved from broking to trading and was an option trader on the floor for a company called Smith Brothers (a venerable old Jewish stockjobbing firm) Smith Brothers became Smith New Court and eventually was bought out by Merrill Lynch. I was a senior trader and was especially skilled at first day trading in the recently privatised UK companies like Jaguar, British Airways, British Gas and Rolls Royce. Shouting and screaming and being quick with arithmetic was my forte. I loved it. We all knew that one day the game would be up and that all the fun we were having would have to be paid for. The piper always takes his wages. And talking of wages, the Big Bang in the City created yuppies. I was a Yuppie. Filofax in hand and even a Motorola Mobile phone. Yes, for those that can remember them they resembled a brick. That summer leading up to the crash worries started to emerge. We had the odd spasm but nothing more that tremors before the big eruption in October. Now at the time it was a heady party in the market and there was a belief that it was never going to go down. Every pullback was another buying opportunity. As an option trader it was money for jam. All the institutions did was sell us puts which ultimately went out worthless. We bought puts by the bucket load. Thousand of them. Now if you know option hedging if you buy a put you buy the stock to hedge it. You buy with a delta ratio. Not wishing to get too complicated, but the stock we bought kept going up and covered the loss from the puts that we had been buying. It was a simple strategy. Everyone was happy. Institutions figured that if the market slipped back and they had the stock ‘put’ on them they would be happy to be buying. After all the market only ever goes up, doesn’t it? So, the game continued. The instos earnt extra income and looked very clever in the brave new world and option traders like me took on the risk and bought the stock. Salaries soared as profits rolled in. Privatisations gave everyone a stake in the new stock market bubble. My salary went from GBP1701 to GBP40,000 over that period. 1700 pounds did not even cover my car loan when I started. Didn’t even cover my season ticket so I worked for my father during the holidays on building sites and weekends to earn enough to eat and play in the City. With the increase in our salaries came a belief that we were invincible. We were early 20s and Masters of the Universe. All that was to end.

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At that time there were a lot of international traders in the London Traded Option Market (LTOM). The Dutch were there in force and I was pretty tight with my Dutch friends. They liked to party and had huge expense accounts to boot plus they knew options. They practically invented them. Think tulips. Anyway the Friday before the Black Monday crash I was in Amsterdam having flown through the Hurricane that hit London the night before. Needless to say, I had a fabulous weekend in a great city with some lovely people. Sunday night I flew home and knew that we were in for a serious week. The market had been closed on the Friday as people struggled to work and tried to get through the physical carnage that had hit London.

So, there we were at Smith Bros, a bunch of young traders who owned all the puts. A lot of them were October puts (if the crash had happened week later things would have been different). We had a huge equity trading operation. It was not a big form and the company was long. Seriously long going into the crash. With the new computerised trading that had just been brought in adding to the complications. After some crisis meetings we were ready to take the floor like gladiators. We knew it would be make or break for the company. And so it began.

The falls were mind numbing. We did not have computers in those days so it was impossible to make prices on options and know your positions from minute to minute. The only thing we knew was that we were all very short. As prices plunged through the strike prices were got shorter and shorter. We had to buy stock to re hedge our delta exposure and buy lots of it. You would think that buying stock would be easy in a crash. Just stand there with a buy pad and write out the slips. No such luck. Under our company rules we were only allowed to trade with our own equity market makers. So, a phone call, yes, they were phone calls, to the dealing desk in equities to buy 1m Rolls Royce shares was followed with a short sharp two-word sentence one of which was off. We could not buy enough stock to cover our shorts. The equity market makers did not have the capacity to sell as much as we wanted and believed that a rally was imminent and there was no value in selling a spotty option trade 1 million Rolls Royce at the bottom. Of course, it turned out that it wasn’t the bottom. FTSE 100 fell by 10.8% on Black Monday itself, and 12.2% on the following day.

We made millions that week. Puts that were worthless were suddenly worth fortunes everybody was buying puts to cover or we were buying as much stock as we could to hedge our position. It was frantic. I lost my voice and couldn’t talk properly for the following week. Fortunes were made and lost that week and as usual we washed them down with the yuppie drink of choice, Bollinger. We were heroes. When eth option trading team finished the first day we walked up to the equity trading floor (remember it had all gone electronic by then) and were given a standing ovation. It was like winning the world cup. We walked amongst our peers swapping war stories and offer congratulations and commiserations. The upshot was the option traders had made a profit of GBP9.5m on that day. The rest of the firm had lost GBP9m. Smith Brothers was still in business. We had saved the firm. Bonuses all round.

And so the week unfolded. Day after day a similar story. My girlfriend at the time was away on business and a nightly phone call really didn’t do it justice. Besides I was usually in the Arbitrageur Bar drinking and dancing on the ceiling.

The only problem seemed to be that after the crash, no one else wanted to play anymore. Wounds were being licked. Traders were being let go and the world of the yuppie changed. ‘Wall Street’ came out and we had ‘Bud Fox’ and ‘Gordon Gecko’ to model ourselves on but it wasn’t the same. For the following two years option traders in London came in every day and twiddled their thumbs me included. If someone wanted to trade the competition was so fierce that we also jumped on a buyer or a seller with enthusiasm. After two years of holding out and playing dumb games, I saw an ad in the FT for traders to come and trade options and derivatives in Sydney. My way out. And here I am 28 years later.

So what lessons can be learnt from all this and how does it relate to the current market.

Well it is pretty fully valued. Complacency is rife and we have some serious irrational behaviour going on. Bitcoin is just the tip of the iceberg. But it does not feel like 1987. Things had got really out of control by then. Since then of course we have had other crashes, mini crashes and the mother of all crashes the GFC. What differs from 1987 to 2008 was that the ‘87 crash was confined to the stock market primarily. It really didn’t spill over to the real economy or jobs. It threatened to but never really did. We had a recession we had to have and house prices became the bubble and then crashed. Interest rates went through the roof. In the GFC everything was infected. The banks nearly collapsed and we were on the brink of another great recession. Luckily central banks stepped in and saved the day. Record low interest rates have saved us but have enslaved us through massive household debts.

So will we see another crash? Yes of course we will. History does repeat. Will it be soon? I suspect that is unlikely given the low rates and the lack of alternatives. Will some bubble markets crash? Yes. Bitcoin may well do, Brisbane apartments may well do a swan dive. Who knows? The one lesson that I learnt from that crash, and the subsequent ones, is avoid over leverage and have some cash around for those opportunities. The GFC and other crashes are rare events and when they happen, fortune favours the brave and the market gets irrational and traders throw everything out in the search for liquidity. It will happen again. That is why you must keep a buffer and have cash ready to be deployed to snap up those once in a lifetime opportunities. The investors that got seriously hurt were those that had massive leverage and had to sell at any price. The smart money bought. It is easy in these heady times to throw caution to the wind. Fear of missing out is real. I have even contemplated buying Bitcoins. But stick to your discipline. Buy quality companies and have funds ready just in case. And finally, don’t believe your own hype. Hubris is a dangerous thing.

Pride does come before a fall. Everybody looks good in a full-on bull market but it’s when the tide goes out we see who is not wearing any clothes as they say.

Incidentally during the crash our index futures trader had a huge punt on the market bouncing and bought back all the short exposure we collectively had. He didn’t tell anyone and hid his trade until Xmas eve. Somewhat of a shock to find a massive multi-million-dollar loss that carried our bonuses down the Thames but that is a whole different story and one for another day.

Henry

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