Odd Lots - How One Trader Won Big While Everyone Else Panicked on Black Monday

Episode Date: October 16, 2017

On Monday October 19th, 1987, the Dow Jones fell 508 points in a one day crash that will forever be known as "Black Monday". In honor of the 30th anniversary, Joe and Tracy talk to Blair Hull, managing partner of Hull Trading Co., who was actively trading that day. While everyone else panicked, Hull spotted an opportunity and won big in the chaos. On this episode, we talk about how he was able to keep his head above water and what lessons that day holds for markets today.See omnystudio.com/listener for privacy information.

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Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, radio. and wherever you get your podcasts. Hello and welcome to another episode of the Oddlots podcast. I'm Joe Wisenthal.

And I'm Tracy Allaway. So Tracy, we have a lot of anniversaries coming up in terms of major financial news and events in financial history. Oh, yeah. Well, we have, let's see, the 10-year anniversary of the 2008 financial crisis. That's next year. But even more importantly, I think we have the 30th. anniversary of the movie Wall Street coming up in December. That's the one I'm the most excited about. That's the real, that's the real. That's the big one. Yeah, I know. I think we may have talked

about it before, but I'm kind of dreading the next two years and hearing everyone, including many of our colleagues, just endlessly recant war stories about I was there the day this bank, you know, went bankrupt and here's the thing I wrote or whatever. It's like, we're going to have two straight years of that. Joe, I'm going to love it and I'm going to force you to sit through an entire Odd Lots episode where I just talk about September 2008. All the great coverage you did during that time. Yeah, exactly. But besides the movie Wall Street and besides the financial crisis, we are at another really important 30-year anniversary. And of course, that is the 30-year anniversary of the Black Monday crash in 1987. Oh, has it been 30 years already. Can you believe that?

We are old. We are old. You know, we think in our history is like, okay, there was this crash. The stock market fell a lot in a very short period of time, and then the stock market recovered, and then we kind of move on. But I think you would agree that there's a lot of fascinating stuff to unpack from this experience in terms of what it tells us about. how markets work and how traders work and all kinds of stuff like that. Oh, yeah. People have been drawing lots of parallels to Black Monday recently, and I'm sure we can get into that later. But more importantly, I think there's a tendency as we get further and further away from

these events to kind of forget about what a big deal they actually were at the time. And Black Monday in particular was huge for markets and led to some regulatory reform. but when you contrast it with what happened to 2008, it kind of seems like there was a fairly quick rebound. But, you know, the actual day, the actual event was just huge and full of drama. Not that I was there, but. No, but from what we understand, I don't recall it either. And not that I, not too much of us had.

I was seven years old at the time, but I don't remember it in the news. I mean, I was kind of aware of some stuff. Do you remember it? No, I was even younger. I thought you were going to tell me that you were trading futures at the time. No. Euro dollars or something. Okay.

I was not. Anyway, I'm very excited about today's episode because we are going to be talking about someone who, unlike us, lived through Black Monday. He was an active trader. He still is active, but he was active during the crash. And he's known for having made crucial trades the day after that performed very well. So I don't think, I think we're going to get a very rare perspective on this event today. This sounds amazing. I want to hear all the anecdotes. Me too. So without further ado, I want to bring in Blair Hall. He was the founder of Hall trading company in 1985, so just a couple of years before Black Monday.

He's still active in proprietary trading. He has a firm called Ketchum trading. He even has an ETF that's based. based on his market timing. And he's featured in Black Monday Revisited, an oral history of the crash. It's put together by Richard Dewey. It's running in this month's issue of Bloomberg Markets Magazine. It's really awesome. Amazing oral history. He also features Peter Borish, Michael Lewis, Jim Chanos, Nassim Thelib.

Got to check it out. So pretty much the perfect person to talk to about this historical episode. Blair Hall, thank you very much for joining the Oddlots podcast. Tell us, first of all, I'm curious, what did you make of our intro? Do you think we characterized the events of 1987, or we basically sort of framed its historical context well? And can you tell us what you were doing at that time, career-wise and professionally leading up to this big event? Well, at first, I think, first of all, the 87 crash was caused by some factors that we need. now know about and as a result we have made some market reforms that I think will reduce

the probability of a catastrophic event in financial markets. What happened is the market had gone through some, was down 5% the previous week and then it was down on Monday and everybody knew that it would be down again on Tuesday but we didn't know to what an extent or there was exacerbated the crash and caused this extreme movement. Wait, but wait, we're going to dig into all of that, but before we do, what were you doing before 1987? Well, I was a marketmaker. Actually, I had been a blackjack player before then.

I was a card counter in Las Vegas. I had bought a seat on the Pacific Stock Exchange, and then I had built a firm that had about 20 employees that were making markets in index options and futures and stocks. And so we had a presence on most of the major exchanges at that time. And one of the things we had is a screen that would automatically provide option quotes. We were one of the first people to automate the process of creating quotes for as an options market maker. And I was on the Chicago Board of Options Exchange in the SPX pit, which had just been, so that morning, Tuesday morning, that's where I, I, so from what I remember, options were booming in the 1980s, right? And that was

partially off the back of the creation of black shoals or the discovery of black shoals. Can you kind of walk us through what that market looked like, you know, the day before Black Monday or Black Tuesday happened? Well, the Chicago Board of Option 6th or the American Stock Exchange on the S&P 5. Blair, there's so many things that I want to ask you. But I feel like I'm going to forget to ask you about this if I don't do it right now. But just briefly, tell us a little bit about the skill overlap between going from being a blackjack card counter to a, you. stock trader, we talk about gambling a lot in various ways on this podcast. But I'd love to hear it

from your perspective. What specifically is the skill set that sort of transcends both things? One is dealing with risk and capital fluctuations. That's one skill. Working with a team, I was part of a team playing blackjack in Las Vegas. And so both of those skills, first of all, the capital fluctuations, even though you have an advantage in any kind of a game or a marketplace, you will have capital fluctuations and capital drawdowns. You will go through bad and you have to be able to withstand those loss operating in a reckoning to deal with your emotion. You need to be able to work with other people. And is this so that in the context of Blackjack so that the casinos don't recognize you as a card counter? Oh. No, no, that wouldn't

be. It's just in terms of just working in a team, collaborate with others. Got it. So, Joe always brings it back to either gambling or chess, usually. But just to stick to the theme, I mean, there is a link between gambling in Vegas, say, and Black Shoals and Black Monday, right? Like, people talk about the Kelly Criterion and Ed Thorpe and Merton Shoals. Can you kind of square that for us or give us the background? I always say it's getting in the game is knowing how much money to put on the table at any one. time. And if you lose half your bankroll or half your trading account, you must reduce your size. And so that relates to the Kelly criteria of knowing how much and being able to adjust

that as either increases or decreases. Let's go back to the events of Black Monday. So one thing I realized we didn't say is that how bad Black Monday was. For people not familiar with it, the Dow fell over 20% in one day. Absolutely. 508 points famously. Which, you know, these days may not be that much or kind of, you know, a volatile day. But just an absolutely extraordinary one-day sell-off, the likes of which financial markets had really not seen before on such a grand scale. There's also crashes all around the world. But let's go to that Tuesday.

So walk us through the event. Obviously, everybody completely fried or stunned by the events of the day before. tell us about how you were thinking going into the markets that Tuesday morning and how people were behaving. That actually displayed our prices in the SPX. So these were prices that you allegedly could trade on. And in today's market, you can trade on them. In those days, they were. And so we gave our best estimate of where volatility was.

And I don't have the exact numbers here. But I think we were guessing that volatility would have 40. But when implied volatility opened at 60, it was as the lead market maker in the SPX pit, we were essentially run over by orders. We could not respond to move our markets fast enough to even stay somewhat in the game. There was a fighting to get any kind of. So an open outcry pit, people are physically trading, right? were you doing the hand signals and all of that?

Oh, it's voice and hand. So what was the atmosphere like then on that day? And there was at that time. There were a lot of people in the pits. In the week, Fed had increased capital required in the pits. That morning it was. So what did markets do in the early hours of that Tuesday? And then what did you do in particular to sort of, you know,

take a spot an opportunity in the chaos? And why did you sense that there was an opportunity then? What happened is the market actually rallied Tuesday morning. And we suspect that was because of the portfolio insurance orders that had not been. The market had a steady decline. At that time, the Chicago Board of that called the Major Market Index, and we were one of the larger market market makers trading across index products. So we had positions in the New York Stock Exchange index in the OEX and the SPX position in the major market injects at the Board of Trade, which was a mirror of we had positions all across the board and had to keep track of whether we were to the marketplace. But the reason that I had to go over to the major market index

was that there were no broke that could execute our Mergantiel and the Board of Trade had said, you must have at least $100,000 in your trading. And there was no broke. We happened to have a seat. And so I could go over and would not norm at trading in one of those futures. You jumped in. But this is what I want to ask because in the 2008 financial crisis, one of the accusations thrown at some of the big market makers was that they just

stopped picking up their phone and taking orders. Was there any of that on Black Tuesday? I realized some people couldn't trade because they didn't have enough capital. But did anyone just kind of throw their hands up and walk away and say, this is too much? Yes, essentially, the specialists in New York were not picking up the phone. In Chicago, there was a pit. So there were those people that were there, and some of them would be quiet. And others would, in fact, one of the, one of the, One of the things, a colleague over at the scar by the name of John Stafford together, and one of the things that he did is he said that when somebody comes in with an order, you always respond to them, even if you can figure out what the price should be,

because these are complicated. But you always respond to them. It may be with a ridiculous price, with an extremely wide market, but you always respond. So I was in the mode of always responding to, which sometimes can get you into trouble. but in this case it worked to my advantage. I'm Francine Lacquois, an award-winning journalist, and I've got a new podcast, leaders with Francine Lacqua from Bloomberg Podcasts.

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Fill in the details there in terms of how it worked to your advantage. You had this opportunity of essentially being the only person in this position that you were in. How did things then sort of settle out for you in the days and weeks ahead? The key was that morning when the market continued to decline. And, of course, it looked like it was never going to end. What I did was that I was in the major market, small buyer trying to reduce our short position. So I was buying five small lots of twos and threes and fours and fives. Our position trading on the Chicago and the Chicago Mercantile in the futures contract.

That was the big contract. And so if they halted that, I was fearful that they would halt for a couple days even. I actually asked somebody from the firm to go over to the library and do research to determine, what happens on trading halts. Now this was a completely ridiculous request. We didn't have time to say that we didn't have Google. I had a sense that it's a buying opportunity because it depends. And so I told the firm to be long on the halt. So we were and they needed to sell. They knew that it was actually keeping that market open the entire but I wish he had not panicking and closing the markets. The decline, Drexleberna had a big order to sell.

and knowing that I was, I had been probably the only buyer in the pit. They, and they said, you own them. I immediately told the first, and I think one of the things is the market was trade $290. It would have been $290 at $2.95, and there were bids at $290. He actually, because it was a large contract, he said, I'll sell him at $285. So I bought these contracts, $287, trades $2.80. I considered sharing some of those contracts with the rest of the pet, and by the time, anything could happen. So it seems so simple in retrospect that you kind of stayed calm and started buying when other people were really panicking and selling.

What was it that you saw that other people like Drexel didn't? Or what was it about your position that allowed you to do that but prevented them from doing a similar thing? Well, I was providing liquidity. So they were forcing the market. I did have a sense. I did know that I didn't know, but I had a sense that a trading halt provided an opportunity. So that was the reason that I provided liquidity on that side, especially. And it was also in conjunction with the fact that the feds had raised margins.

So we then also had to reduce position. So we have to just about wrap it up here. but I have one very quick question, one slightly longer question. The first question is, can you tell us how much in the end your firm made from this trade? But more importantly, as we look at the market now and people worry about whether we see things like the echoes of portfolio insurance reemerging and other sort of volatility products and so forth, what do you think are the key things to understand about the vulnerabilities of market structure today? Actually, I do know Mark Rubinstein, who was really the creator of portfolio insurance. And actually, I have a house in California.

And he was at a party at my house after the crash. Must have been early November. It's so sad. He was distraught. He said, I caused the crash. Even though it wasn't well known at that time, it was in fact true. that the crash was exacerbated by portfolio insurance, which now today with the liquidity that is in the market is probably a very viable product. He was distraught. He's a very honorable man,

and he, along with John O'Brien, they were the liquidity that is proprietary traders, I think portfolio. So there's just two ahead of the time. Can I just press this issue? Because a number of people have brought up parallels to portfolio insurance. So, for instance, the risk parity strategies that kind of assume a relationship between bonds and equities, various types of programmatic trading, sometimes even volatility trading. Do you see any parallels between, you know, a potential Black Monday, Black Tuesday situation and some of those more modern strategies? I haven't thought about this to a lot. large extent. But I don't think there's, I mean, at that time, this was a tremendous, there was a

tremendous amount of money in this strategy. I think they're more diverse strategy. Parity is, can be adjusted over periods of time that have to do with the volatility of each instrument. I don't see one strategy that is overwhelming the others. Really, this decline in volatility. I find it interesting that we're not, we're in a very stable. From our perspective in the press, we might even say it's too stable. We need more interesting stories. Blair Hall is fascinating to talk to you. Great to get your perspective. Love hearing the stories of the sort of different era of trading. Really appreciate you coming up. My pleasure. So, Tracy, I love hearing about sort of different eras of trading and what it was like. And so obviously crashes and huge crashes can happen at any time. there'll be big ones again in our future.

But thinking about things like being the only person physically in the room or having to go to the library and look up how the rules of a trading halt could theoretically affect markets, that's distinct to a certain time. And it's sort of like, you know, I find it very interesting. Yeah. I thought it was really sad that little bit, that anecdote about Mark Rubinstein going to the party and saying that he caused the crash. because, of course, the whole idea about portfolio insurance was that you protect yourself in times of crash.

So, poor guy, kind of. You know, one thought that struck me, some things are the same when it comes to trading, like the notion of some market makers just panicking and not picking up their phones. That happened, you know, in 2008. But I wonder if there's one thing that's different now, and that's the sort of regulation and legal aspect of everything. Like, I just wonder, if you really had the market falling apart, how many compliance people are you going to have descending on your market making

or maybe even prop trading units or teams telling you that you can't, in all honesty, do anything because you just don't know what's going on and you have a whatever, an obligation to your shareholders or clients? I just wonder if that's the thing that's going to change this time around. Yeah, and it's really interesting that lesson, that sort of trading lesson here related about, you know, if you don't know what to do, don't say you don't know what to do, don't not answer the phone, just go out there with a ridiculous quote. So just in other words, give yourself a huge margin of error to be wrong.

And if the client, if the person on the other end of the trade doesn't want to take it because they think that's a ridiculous quote, then okay, they don't have to. but if they do take it, then you give yourself the opportunity to make a, you know, you put the choice back on them, but you give yourself an opportunity to potentially make a lot of money. It just seems like one of those interesting ideas about how in a period of extreme volatility or extreme moves, you can sort of protect yourself in that way. Continue your obligation as a trader, as a market maker, but give yourself, you know, that cushion. But again, you have to have a lot of autonomy and a lot of confidence.

to do that. And I wonder if that's kind of what's lacking in modern finance. I guess we'll find out the next time we have a flash crash or Black Friday or Black Monday or Black Tuesday or Black any day of the week type event. And there will definitely be those days. And hopefully we're still doing our podcast by the time the next one comes so we can talk about it. Yeah, and we'll actually be there and we'll have war stories of our own to tell. Exactly. This has been another episode of the Odd Lots podcast. I'm Joe Wisenthal. You can follow me on Twitter at the stalwart. And I'm Tracy Alloway. I'm on Twitter at Tracy Allaway. And you can follow our producer, Sarah Patterson, on Twitter at Sarah Pat with two teas. Thanks for listening. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris.

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