Implied volatility spiked from 20 to 170 percent in the 1987 crash.

Evidence

The sudden, huge rise in the prices of index put options some rose eightfold (Brady Commission 1988, p. VI-19), with implied volatilities, normally around 20 percent or less, soaring to 170 percent (Bodie and Merton 1995, p. 217, figure 6-1)-meant that enormous margin payments were owed to clearing firms by market makers who had sold options that had shot up in value, and by the firms to the Options Clearing Corporation. First Options, the leading clearing firm, absorbed huge losses from market makers who could not meet their obligations. Its failure would have been a calamity, but it had shortly before been bought by Continental Illinois, and the Federal Reserve permitted the bank to draw on its capital reserves to replenish First Options’ funds. — Donald MacKenzie, An Engine, Not a Camera, 919

Categorization

• QUESTION: The Fed’s capital-reserves workaround for First Options suggests a mechanism of implicit backstop support — worth chasing how formalized or discretionary this became.
• XREF: connects to: The 1987 crash was a 27-sigma event under the log-normal model. — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 142; The 1987 crash permanently broke Black-Scholes fit with market prices — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 150; The 1987 crash exposed limits of arbitrage as a mechanism linking markets — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 822 (+5 more)

Broader Connections

• The 1987 crash permanently broke Black-Scholes fit with market prices #expands (0.85) — Donald MacKenzie, An Engine, Not a Camera, 150
• The October 1987 crash ended the flat volatility curve predicted by Black-Scholes #expands (0.85) — Donald MacKenzie, An Engine, Not a Camera, 900
• The post-1987 volatility skew became a permanent feature of index options #expands (0.82) — Donald MacKenzie, An Engine, Not a Camera, 901
• The 1987 crash exposed how fragile the options clearing system was to extreme prices. #expands (0.80) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 164
• The 1987 crash exposed limits of arbitrage as a mechanism linking markets #complicates (0.78) — Donald MacKenzie, An Engine, Not a Camera, 822
• Post-1987 option pricing may be rational given the crash’s trauma, not irrational. #qualifies (0.75) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 155
• The 1987 crash traumatized U.S. derivatives markets in ways absent elsewhere. #expands (0.72) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 165