Financial History 140 Winter 2022 - Page 14

THOMAS PETERFFY Chairman and Founder , Interactive Brokers Group
I came to America when I was 21 and not speaking the language . One of the few things I could do was to learn computer programming . I soon found a job on Wall Street at a commodities trading firm as a programmer . There was more and more talk about things called puts and calls and how nobody had any idea how to calculate proper prices for them .
I took it upon myself to try to figure it out on my own computer . After months of building different computer models , I had one that could create prices at which — after all simulated buying and selling of different kinds of options — I would break even . In other words , the model could calculate the fair price of an option .
The model turned out to be a computer coded generalized solution of the Black- Scholes formula , which at the time I didn ’ t know about . In 1975 , call options began trading at the American Stock Exchange . By 1977 , after put options were also listed , I saved enough money to start a market making business . I got up my courage , bought a seat on the Amex and became a market maker on the trading floor .
Right from the very start , it was evident to me that floor trading must be computerized . There were about 20 series of listed options on each stock and five traders including the specialist . He was supposed to keep track of which of the five traders bid or offered how much for which series , in what time order , and allocate the trades accordingly . This was a physically impossible task for a human , but very easy to do with a computer .
I started lobbying the exchange administrations . I tried to convince them that they must computerize the process , but the specialists did not want to hear about it . Given that the price-time priority was based entirely on their subjective recollections , they could do anything they wanted . The same was true for the most influential market makers on the CBOE .
By 1986 , we had built a completely autonomous system that generated bids and offers for all of the listed options at the time . Had we had an electronic exchange , we could have built an entirely autonomous liquidity provider . Our greatest challenge was to get our bids and offers to the floors and to have people recognize them and trade with us .
Starting in 1990 , electronic options trading was introduced in Europe and Asia . We immediately offered to provide liquidity and connected to these exchanges . This was great business , and we did not need too many employees to supervise the automated system , unlike in the US open outcry exchanges where we had to have live humans on the floors . The large specialists , the market-making firms , had practical voting control of the US exchange boards and did not want to move until it became absolutely evident that if they did not go electronic , they would lose to new competitors . Our existing worldwide communications network , our connections and memberships to all the exchanges and our vision of a global electronic exchange network connected to potentially billions of investors prompted us to enter the electronic brokerage business in 1993 and incorporate IBKR .
Finally , in the year 2000 , the first US electronic options exchange , the ISE , started . This was the first instance when our automated market maker algorithm and our customers could interact with a US options exchange without any human intervention . At the time , we employed over 200 exchange members on the other US exchanges to do 10-15 % of the national volume , while we did 50 % of the volume on the electronic ISE with just two people watching in our office .
In the first decade of the new century , all US exchanges grudgingly converted to electronic operations . As a result , from the smallest to the largest firms , floor staff and back office staff were reduced sharply , error rates diminished , reports became real time and , eventually , transaction costs plummeted . The 2008 market crash did not break the new electronic market infrastructure . It was proven to be more solid than the open outcry days of 1987 .
By 2010 , some market makers began to buy order flow from retail online brokers . Interactive Brokers has always insisted that even though we were brokers and market makers , we never traded against our own customer orders and we were not about to change that . In the next several years , almost all the direct customer flow dried up , and market making on the exchanges became unprofitable . We got out of that business and have been focusing solely on the brokerage business ever since . Thank you to the Museum of American Finance for the Lifetime Achievement Award .
MICHAEL MILKEN
Chairman , Milken Institute
Thank you to the Museum of American Finance and congratulations on your 2022 awards , which honor America ’ s financial heritage . I am pleased to have the honor of introducing my long-time friend , Steven Mnuchin , who is being presented with the Whitehead Award for Distinguished Public Service and Financial Leadership .
It is often said that luck occurs when opportunity meets the prepared mind . In so many ways , the United States and the world were lucky that Steven Mnuchin was Treasury Secretary when the worldwide pandemic hit in the first quarter of 2020 . His lifetime of personal experience and significant knowledge of modern financial markets prepared him for the challenges we all faced .
I have to say the Secretary was not the first Mnuchin I had met on Wall Street . The first Mnuchin I met was his father , Robert , who was working across the street from me at 55 Broad while I was working at 60 Broad . As a member of the Mnuchin family , Steven was well versed in financial markets and only added to his knowledge when he came out of Yale and joined Goldman Sachs in 1985 . He became a partner in less than 10 years and by the time he left 17 years later , he brought his innovative leadership in running the
12 FINANCIAL HISTORY | Winter 2022 | www . MoAF . org