Dazed and Confused

Unless market makers are "rich" or come from such families, they don't always trade with their own money. A typical trader deal be 50% of the profits, and no risk, with some allowance for a draw. Back in 1987, it required about $100,000 in an equity account please a seat lease on the exchange. Of course, the seat lease cost, trading fees and basically any other cost associated with trading was part of the "nut" (breakeven).

Most traders I know, figure out their "nut" in terms of ticks. So, if your IOM seat lease is $1500 per month, your "draw" is $3,000 and your monthly exchange fees are $400 per month, this
means that the draw postion really requires you to make $6000 per month to cover it. The other
expenses come from the "top" of the account. Of course the numbers now have changed radically,
but in principal, this is how it works today. And of course, on top of this, running a premium
debit requires you to finance a position, mostly at the broker loan rate +1.

So, a trader with a deal like that needs to make $6000 + $400 + $1500 = $7900. Now there are about 25 trading days per month, so your "nut" is $316 and that comes to about twelve ticks. So you know you have to make at least 12 ticks per day just to break even. If your account goes debit (you lose money) you have to make that up, too. You run it like a business. If you "blow out" (go belly-up), you work a deal with the clearing house to earn back the money by doing "order filling".

In my case, my deal was with a stock arbitrage firm. I traded with people who knew every tiny detail about the stock market and they were a NYSE specialist firm, But, the firm had no expertise and the firm hired me because of my programming and mathematical knowledge of the options market.

Of course, any specialist firm "caught" in the crash of 1987 would take a very skeptical view of
"eliminating" risk by "boxing up" an options position. And herein, were some of the seeds of "defeat" because I was forced to completely liquidate a hugely profitable position and "clear the books".

Moreover, I was not so sure that their NYSE losses would make me forfeit what I'd made. Overshadowing this problem was the fact that Continental Bank itself might be "in trouble".

When is a bank "TBTF" ?? Back in 1984 Continental Illinois Bank had to be "bailed out" by
the Federal Reserve Bank. It was (and still is to this day) the largest bank failure in
history. It resulted in Continental Illinois bank becoming a defacto government run institution.

But it also because of that fact that CIB needed to show some profit to "justify" its existence in 1987. As one of Chicago's largest banks and a global player, the institution was regarded as vital to the very existence of the International Monetary system. Continental had a truly global presence, trading rooms in London and Asia, and a majorly important spot in Chicago Finance.

The building was across the street from the Chicago Board of Trade and had a Roman temple
look to it. It was also architecturally identical to the Federal Reserve Bank of Chicago, just across the street. CIB was across the other street from a derivatives exchange and this certainly had future implications for the bank.

A popular thing for banks to do was to try to diversify income from assets in the 1980s. And instead of selling toasters, Continental made the decision to buy a major brokerage player and institutional trading player from a prominent Market Making firm at the New York Stock Exchange.
Remember that back then the situation was a flattening yield curve. Banks make money in steep yield curve situations, when they canb borrow short (liability management[checking, money market and FX trading,) and lend long (selling mortgages and long term corporate lending).

Rules were quickly established for market-makers (customers of the new CIB brokerage house, as a
clearing member) on all exchanges to not allow trading in any agricultural derivatives. Any trading would be done in strictly financial instruments.

On October 19, 1987, over at the CBOE, a member of the CBOE and a customer of this brokerage house had an uncovered put writing program. Losses from this alone topped $60 million. Total losses for the crash market makers topped $90 million at this brokerage house.

As a result, Continental Illinois Bank, with guarantees from the Federal Reserve Bank loaned the brokerage house $90 million to avoid default. This event was unprecedenbted. It meant, essentially, that the US taxpayer was underwriting the results of an incredibly risky naked put writing strategy, executed by a few young, brash traders from the Orient on the floor of the Chicago Board options Exchange.

Back in the brokerage house members' lounge, I asked the brokerage house office manager if I could draw a check for a portion of handsome profits, following my profuit taking.

He answered, "We are not issuing any checks at this time or for the forseeable future".

I went home that night and drank heavily with the locals at Ruthie's tavern on Kedzie. The multi-day crash had raised my blood pressure to near stroke levels and I'd been up about 72 hours at that point first partying, then fretting.

My father told me, "nothing significant happened". To the layman, this was true and it explained
the spurt of equity buying in the coming days. But, I had just traded through and lived through
a 7 standard deviation market move, which had the approximate probability of occuring once every 7,000 years.