When people think of the great minds who launched options trading over three decades ago, the names that usually come to mind are Fischer Black and Myron Scholes because of their work on the foundational pricing model that made it all possible. One important name that often gets left out when the “Black-Scholes” model is mentioned is that of Robert Merton, who helped them craft the original papers and equations of the quantitative tool that revolutionized finance. But, Merton did receive credit when he and Scholes were awarded the Nobel Prize in 1997.

Fischer Black, sadly, died of cancer in August of 1995 and was unable to share in that glory, or have his name on the prize because it is not given posthumously. But his essential role was recognized by the Nobel committee and rightly his name lives on in the annals of derivatives history. He will probably be spoken of highly next week in many reminiscences when Scholes and Merton are scheduled to attend a symposium being called “The Engineers of the Options Revolution,” celebrating the 35th anniversary of the Chicago Board Options Exchange. Finance professionals and practitioners (traders) from the investment firms and exchanges of Chicago—the birthplace of listed options trading—and from around the world will be there to hear straight from the men themselves what it was like to be at the epicenter of derivatives. But, many will also be there to hear from three more great innovators who used that launch pad to create three of the most successful enterprises in options trading. 

Thomas Peterffy, Blair Hull, and Jeff Yass are to options trading what GM (NYSE: GM, Bullboard), Chrysler, and the Japanese auto makers are to cars—they didn’t invent “the model” like Ford (NYSE: F, Bullboard) did, but they certainly came up with a slew of ways to expand and perfect it. If you worked on a trading floor in Chicago—be it for equity options, commodities, or financial futures—and didn’t know who Timber Hill, Hull Trading, or Susquehanna Investment Group were, you weren’t paying attention very well.

Peterffy, the founder of options market making firm Timber Hill and later Interactive Brokers, the extremely successful trading platform for direct access to all markets, fled communist rule in his native Hungary in 1965. Trained as an engineer with a background in logging, he came to the U.S. speaking no English but eventually learned computer programming. In the 1970s, he worked as a technology expert for a commodities trading firm and began his education in options. By 1977, he was a market maker with a difference on the floor of the AMEX—he was one of the few traders who carried “sheets,” the computer printouts of option theoretical values from a pricing model. Soon he was the only trader who insisted on carrying a “portable” computer (for the early 1980s, it was the size of a small suitcase) strapped around his waist to trade. Initially, his project met with great skepticism and computers were even banned from the pits on other exchanges for a time. This, of course, did not stop the ever-innovative Peterffy who merely invented another technological solution—adapting floor monitors with color codes to guide his traders about which options were undervalued and which overvalued.

In spite of exchange hurdles and fellow trader suspicions, Peterffy’s insistence on having the technology at his finger tips to trade options with customized, adaptive pricing eventually paid off and it gave him a significant, and legitimate, edge over other options traders. He didn’t merely take advantage of the conventional edges of bid/ask spreads (which every other floor trader was already trying to do) and then hedge the risk to remain delta-neutral—he used the fluid nature of volatility and computing power to exploit option “mispricing,” when opportunities for nearly risk-free arbitrage profits could be executed. This new-found edge proved big enough for him to start his own firm in 1982, where all his traders could apply technology to options arbitrage in the pits. Peterffy’s aggressive innovation helped vault options trading into the computer age, and it paved the way for Hull and Yass to build their own brands of technology-based volatility trading.

Blair Hull began trading options in the late 70s and in three years turned his $25,000 stake into half a million dollars. By 1985, his continued remarkable trading success allowed him to start his own market making firm which grew to nearly 100 employees and $90 million in profits by 1991. Jeff Yass started trading options in high school as a natural progression from his love of the stock market as a kid. After college, his sole interview with an investment firm left him convinced he knew more about options than most supposed experts when he found the head of the firm’s option department didn’t understand volatility trading. Yass ended up on the floor of the Philadelphia Stock Exchange in 1981 and his independent-minded approach gave him the means to gather a group of college buddies and start the Susquehanna Investment Group in 1987. SIG has since grown into one the largest privately held financial institutions in the world, with comprehensive trading, technology, and research arms.

I first learned about Blair Hull and Jeff Yass in Jack Schwager’s 1991 book The New Market Wizards. Their stories are right next to each other and in them is revealed something else they have in common besides being wizard traders who multiplied their success by training and capitalizing small armies of systematic option pros: they both learned the practical application of options volatility trading, namely probability, from playing cards. Hull was a semi-pro blackjack player in the mid-70s who was recruited by one of the infamous MIT blackjack teams and Yass played poker in college like it was graduate work.

By the time I worked on a Chicago trading floor in 1994, you could tell who the Timber Hill, Hull, and SIG traders were instantly, and not just by their jackets. In the S&P 500 futures pit at the Merc, they were the groups of traders who used their notepad computers almost without exception because their trades were instantly fed into the home office trading system for sophisticated arbitrage between there and the SPX options pit at the CBOE. 

As part of the 35^th anniversary celebration for the CBOE, these five greats got together for a panel discussion last week. Whether or not I’m able to separate the facts from the legends, the dialog between these greats alone was worth the price of admission.