An Interview with Alex Jacobson, former vice president of education at the ISE
Alex Jacobson recently retired from the International Securities Exchange, where he was vice president of education. He is also an instructor with the Options Industry Council, and he was a founding member of the CBOE Options Institute. He spoke with Sarah Rudolph about the history of options education and the changes in the industry.
(This is part one of a two part interview. Part two will appear in next week’s JLN Options Newsletter.)
Part One: History
Q: You have had a long career educating people about options. Did you start out at the Chicago Board Options Exchange?
A: No, I started out as a charter member of the IMM [International Monetary Market]. I went to the University of Illinois Chicago Circle, and I clerked at the old Chicago Mercantile Exchange at 444 W. Jackson. When I went to school at the Circle all my finance professors were University of Chicago Ph.D candidates paying their bills by teaching at a cheap university. So I got a million dollar education for nothing. I went from 1970 – 1974, and the financial markets began in 1973.
I had an interest in the markets because on the street where I grew up, the biggest house and the biggest car belonged to a pork belly trader. So I had a keen interest in the markets, and they were literally starting as I was getting my education.
When I got out of college I interviewed at Merrill Lynch to become a stockbroker. I had all this financial knowledge. The fellow who interviewed me said, basically, “Go away and come back when you grow up.”
So I bought a CME seat with my Bar Mitzvah money. It was $10,000. In the early days of the CBOE and the International Monetary Market, they couldn’t give their seats away. The seats were often assigned to members with a pay-for-it-later plan.
The CBOE started out in the CBOT building. At first, people were not big supporters of what was to become the most important financial derivatives market in the world.
The 1973 oil boycott murdered all Chicago finance jobs. At that time the three big banks — Continental, Harris and First Chicago — were the players. I couldn’t get a job, so I began to trade options for myself, through a broker. I finally got a job in the Merchandise Mart at a clothing business, doing their accounting. I worked 50 hours a week at my day job, making $30,000 a year. The options trading was making me $70,000. I realized it was a bad division of labor.
So in 1980, I decided I really wanted to go into the options business. I answered an ad for career night at Merrill Lynch – and I saw the same guy I had interviewed with six years before.
He said, “Tell me what you’ve done.” So I told him. He said, “Take the aptitude test, you’re hired.”
In the early 1980s, Merrill Lynch was growing their presence and diversifying their broker base. Merrill had been a traditional firm, and I learned I was hired under a diversity quota.
I quickly grew to be successful and developed a great customer base. While I was trading options at Merrill, they made me a teacher in addition to being a stockbroker.
In the midst of a divorce, however, I neglected my stockbroking business. I ended up leaving Merrill Lynch and entering the job market. I answered an ad I saw – in the Sunday paper’s Help Wanted section — for a research position at the CBOE.
In the early 1980s, the CBOE decided to go into the education business. Every research study they did revealed that their customer base was too narrow. Brokers who liked options were too far and few. To broaden their customer base, they developed a pilot program within their strategic planning department with the ambition of building a school. They initially hired me as a consultant, but within a couple of months they made it a full time position. I was there for 17 years.
The CBOE community had mixed views about the school. Much of the market-maker community didn’t support it, because they were afraid it would make investors smarter and they would have more competition.
The CBOE program wasn’t just teaching people about products and strategies, it was teaching risk management. We looked at it from the standpoint that we didn’t just want to raise trading volume, we wanted you to live longer. With education you could trade forever, not just jump in and trade for three months and get blown out. CBOE’s idea was if you educate you win.
My first job was to review the videotapes of the pilot classes. The first thing I did was change Day Three of the pilot class from regulatory and compliance to managing the product: post-trade decision making.
The class was a huge success until October of 1987. The ’87 crash killed all the travel budgets of brokers who were coming to see us. So we had to go out to see them. We created outreach and taught classes on the road. Discount brokerages were becoming a big factor in options, so we started training customers instead of just brokers. We attracted thousands of people. We went from training a broker who would train 100 customers, to training 100 customers.
In 2000 I was recruited to go to the International Securities Exchange, the first electronic options exchange. ISE was the brainchild of Bill Porter, who founded E*Trade, along with a number of Wall Street firms who didn’t want the fixed costs of the trading floor.
Most of the world had evolved into an electronic trading environment, but the U.S. options market was very late to that environment. It was tough. Firms didn’t want to embrace us. Many who had been my customers in options saw the electronic trading as their demise.
So it was rough sledding for first couple of years. When recruited to ISE I was told, for the first couple of years you need to go out and get us a tipping point in volume. My focus was to sell the concept, get exchanges to hook up. We had some big supporters at first, including Goldman Sachs and Deutsche Borse. But weren’t getting the Charles Schwabs, people like that. We went from a one share to a two share to a three share…to a ten share…to a twenty…and by 2005-2006 we were the largest equity options exchange.
What was fun about that was that once we got to a ten share, I got to go back to teaching. We went out to hedge funds, brokerage houses, and user groups. My job was to go around world and teach people options.
Q: Teaching is what you like to do most?
A: That is what I enjoy most. The worst part was the travel. I taught in Australia and Singapore and Stockholm. You travel the world.
The risk management concept was always key. I was training legacy defined benefit pension plans. The challenge was when the markets fell in 2008 they wiped out most of the equity in those plans.
Q: They were harder hit than the 401k plans?
A: Yes, depending on individual choices. In 2008, people who had those plans got whacked. I was calling on a lot of those plans because they had an appetite for covered call writing. I taught them about the CBOE buy-write index. We showed that if you just held the S&P 500 index for the last ten years you had zero profit, but if you wrote covered calls against it you were up around 80 percent.
If you just held individual equities and wrote covered calls against them, you essentially doubled your money.
What had happened with indexing was, people went into “set and forget” strategies. Studies at the time said, “Don’t try to pick stocks — just buy an index fund and buy the lowest expense ratio index fund you can buy.” People did that in 401ks, and corporations did it in defined benefit plans. The problem is when suddenly you get a bad year. Just the other day, the Dow crossed 11,000. The last time the Dow crossed 11,000 was in 1999.
So in the last couple of years the idea became not to hit home runs, just to be able to cover your pension expenses. That led to an appetite for simple strategies like covered call writing.
Q: That was your dominant strategy?
A: Yes, and it was not only teaching them the strategy but convincing them that their investment community should embrace the strategy. A lot of these plans were public plans, for police officers, firemen, teachers and transit workers. The pension crisis was the biggest opportunity for what I was doing. But it sometimes took years between the time you called on a fund and the time they made their first trade. In my heart of hearts I think some of the people I called on hoped that in the time it took to get all the legal approval to trade options, the market would rally and it would fix everything.
Q: So the pension crisis led to people becoming more educated in options?
A: That’s what’s happening now, yes. The trend of farming out to consultants who would hire index managers and bond managers has changed. Now, traditional large pools of money are looking at traditional trading desks again, becoming more pro-active in investing their money.
Q: What do you see as the other biggest changes in the options industry?
A: One big thing was when CBOE created their benchmark indexes. That was brilliant. It made my job a lot easier and was proof of concept to many funds and consultants that here is a strategy that gives you a risk-adjusted rate of return that for the last 10 years has been vastly superior.
The other major change I’ve seen is the growth of volatility as an asset class. And that “set and forget” strategies don’t work anymore.
Q: Active management is where it’s at?
A: Yes. People used to run from active management. Between the Dow crossing 11,000 11 years ago and when it crossed 11,000 the other day, dividends haven’t made any money. And we crossed 11,000 with a great September.
The tragedy was the pension crisis. Even if the folks who have those plans do well from this point forward, a lot of those plans will have a hard time paying what they promised.
Q: What was the best moment in your career?
A: Oh, there were many. But probably being part of the team that brought the business back after the ‘87 crash, and in 2000 pioneering electronic trading, which brought costs down and the public in. The public used to pay four or five times what institutions paid. Today they often pay less. The cost of a transaction once was $15. Now it’s 75 cents.