The 1987 crash exposed how fragile the options clearing system was to extreme prices.

Evidence

In only slightly less dramatic circumstances, John Hiatt and his colleagues at the Options Clearing Corporation stayed awake not just on Monday, October 19, but on the next two nights, and then spent the entire following weekend in their offices dealing with a particular problem case (Hiatt interview 1). Option prices rose to levels that defeated the nascent automated systems, many of which could cope only with double-digit dollar prices. When option prices rose to 106, “it appeared on your sheets as . . . 6… . So your account [with the clearing firm] was off by $20 million the next day… . Nobody knew where they stood” (Hull interview). Enormous margin payments were owed to clearing firms by market makers who had sold options that had suddenly shot up in value, and by the firms to the Clearing Corporation. First Options, the leading CBOE clearer, 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 upon its capital reserves to replenish First Options’ funds. — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 164

Categorization

• XREF: Connects to the broader 1987 crash literature (e.g., Shiller’s narratives, the portfolio-insurance debate) and to clearinghouse-design concerns that recur in the 2008 crisis. — connects to: The greatest systemic danger of 1987 came after the crash, from the clearinghouse’s solvency. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 833; The 1987 crash taught options markets that unhedged put sales posed systemic risk — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 931; Market infrastructure itself failed under the 1987 crash’s order flow — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 820 (+5 more)
• SHARE: The detail that option prices above 99 broke the automated sheets, showing as 6 and making accounts off by $20M, is exactly the kind of systems-failure anecdote a finance-programming friend would love.

Related

• The greatest systemic danger of 1987 came after the crash, from the clearinghouse’s solvency. (similarity 0.88)
• The 1987 crash created unprecedented clearing obligations twenty times normal daily settlement (similarity 0.86)
• Implied volatility spiked from 20 to 170 percent in the 1987 crash. (similarity 0.86)
• The 1987 crash taught options markets that unhedged put sales posed systemic risk (similarity 0.85)
• Legacy systems designed for normal price ranges fail catastrophically in extreme markets. (similarity 0.85)
• Market infrastructure itself failed under the 1987 crash’s order flow (similarity 0.84)
• The 1987 crash traumatized U.S. derivatives markets in ways absent elsewhere. (similarity 0.84)
• Clearinghouse settlement failure alone could have triggered a cascade of 1987 bankruptcies (similarity 0.84)
• The 1987 crash permanently broke Black-Scholes fit with market prices (similarity 0.78)
• The 1987 crash exposed limits of arbitrage as a mechanism linking markets (similarity 0.78)

Broader Connections

• The greatest systemic danger of 1987 came after the crash, from the clearinghouse’s solvency. #expands (0.90) — Donald MacKenzie, An Engine, Not a Camera, 833
• Market infrastructure itself failed under the 1987 crash’s order flow #expands (0.85) — Donald MacKenzie, An Engine, Not a Camera, 820
• Clearinghouse settlement failure alone could have triggered a cascade of 1987 bankruptcies #expands (0.85)
• The 1987 crash taught options markets that unhedged put sales posed systemic risk #expands (0.70) — Donald MacKenzie, An Engine, Not a Camera, 931