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Wayne Luthringshausen has been atop the listed options business for over 40 years. Ahead of bowing out as chairman and chief executive of Options Clearing Corp. at year-end, he sat down with Executive Editor Peter Thompson to outline OCC plans for growth—including its investigation of over-the-counter option clearing—and take stock on the key themes that have shaped the market through his career. Derivatives Week: You’re stepping down after what is it, 40 years?
Wayne Luthringshausen: It’s 40 years. But, I’ve actually been at it longer than that. I started in June 1970 at the Board of Trade on Joe Sullivan’s staff, who was planning the CBOE at the time. I was on the group that planned and created CBOE. What does that make it? Forty-three years I’ve been at this options thing.
DW: That’s quite a unique vantage point you’ve got then.
WL: Well, you know the extent my memory permits me to go there, yes, I’ve been around for a long time.
DW: What do view as being the biggest changes in derivatives over that period?
WL: I couch it in at least two or three eras of change.
In April of ‘73 we opened CBOE. And if you take it from there, I’d probably take it up to around ‘87 to ‘89. That was an era when we were not well known. It was a process of building interest, building activity, of adding products to fill out the needs of the time. In some respects it was a little bit of a wild time in terms of traders and math folks creating strategies, not all of which necessarily turned out to be that intelligent. We started something and this thing really started to look good. Just to tell you really quickly in 1973, Joe Sullivan, who was kind of the father of the CBOE, asked me and another fellow on his staff to put together a very optimistic volume program in five years. In 1978, what kind of volume would we be doing? We struggled with that. We thought we’d average 35,000 contracts per day in five years. I think it was over 200,000 per day. It’s a product that is so valuable. It can be used in up markets, in down markets, static markets. It’s leverage. It’s risk mitigating. It’s income producing. So, it appeals to a very large number of investors.
So that first era to ‘89 was just building it. We’d come through the ‘87 crash. We got through it. When we got to ‘89 we hit another setback. That really turned users away from the product in a much larger way. That really turned the volume down. We haven’t had a lot of years in this business since 1973 when we opened when it’s down from the prior year. But I think ‘89 and maybe ‘90 were down years.
Then you got in to that period around 1989. The chairmen of all the exchanges that were offering options and myself, we got together and decided that we had to put together an educational effort. To better educate the press, which was beating our brains in back then. We had to educate investors. We put together the Options Industry Council. It’s a premier group today in terms of the education it does and the way it goes about explaining and helping users to use the product properly. So we entered this new era that I would say ran probably until the events of ‘07, ‘08, ‘09.
As we were able to help with the education effort, as brokers were able to bring in OIC to help them educate and as firms looked at the product again, we started an even larger run of growth. My sense of that period is that it was probably the golden age of listed options products. In 1987, when the market crashed, we were averaging 1.3 million contracts per day. We’re up to 16 or 17 million this year. The 90s was a market boom. So institutions took a better, harder look at options and began to use them in a significant way. The consequence was volume ballooned. Listed derivatives as an industry became important, because most of the firms were using them in a profitable way. It became an important product—an important business--and it got more attention. So that was kind of the golden age. Everything kind of went to the moon.
The final stage is the one we are in. You go through an ‘08 and even though OCC had no troubles in ‘08—clearing the listed markets—the reality is there were significant derivative issues that the government and regulators focused on. So now we’re in this era of: let’s make sure we do things in a method or form that allows regulators to take a look at how we’re doing and evaluate in a more intelligent way how is OCC performing. Is OCC doing all the things they say they’re supposed to do? That’s where we are right now. It’s much less of a business building focus as it is let’s get all the right pieces in place so that we’re in good stead, so we can go on back to business building. I think there is a future of a lot of volume building in this product.
DW: When you talk of volumes, are you referring to volumes you see through OCC?
Yes.
DW: How is that market carved up in terms of what business has to go through OCC?
WL: All options are listed on exchanges, if they have an options program with the SEC. All of that has to be cleared here. It’s not so much a case of government or regulators saying, “If you want to do this, take it to OCC or you can’t play.” They must have a clearing solution if they want to have a market. The issue is fungibility. An IBM, April, 200 call option cleared at OCC is like a dollar bill. All those specific options are dollars. It doesn’t matter where you trade. You can buy them on CBOE, sell them on BOX. At the end of the day if you’re opening a new market to trade options because you see something of value, you get the instant open interest that exists at OCC for that product. You can go to Merrill [Lynch] or TD Ameritrade and say put those transactions in my market instead of some other market. What that’s good for is it’s good for OCC, it’s good for the firms because they have some power over where they can trade (the regulators do have some rules about that—it’s not totally free). It’s not necessarily good for exchanges, but at the end of the day what it gets done is build so much volume that I think if you went back and studied where were we before fungibility, I think we were at lower levels of total volume.
DW: What is the criteria that draws it in to OCC’s world? Is it a listed option on an equity on a regulated exchange?
WL: Yes. In order to clear through us—in order to be an exchange market—you have to have an options program approved by the Securities and Exchange Commission.
DW: If the SEC approves it, then it has to go to OCC?
WL: If a new exchange was out there today and went to the SEC and said, “I don’t want to use OCC.” I don’t know whether the SEC would say, “No you have to use OCC,” or “Tell us your plan.” Why they have to use us is that it is very hard to convince member firms to join another clearing corporation and put up more funds and have clients in OCC IBM options and that new clearing organization options. It’s the forces of the product and the way the product functions in the marketplace that really have built our dominance in this.
You could say we are a monopoly, but I can tell you we act the opposite way. Monopolies are over priced and over charge and make huge profits. In our case, we make no profit. We charge cost. Our board has been and is still now dominated by the Street, the firms, the banks who are playing our fees. So it’s not like Wayne Luthringshausen walks in to the board and says, “Hey we want to raise costs by another 25%.” It’s not that they’ll turn down costs increase, but at the end of the day we charge a certain fee and then at the end of the year, we give back excess fees beyond our costs and a small profit.
DW: Has the competitive landscape in clearing altered over the last few years?
WL: Let me think about what I want to say here, because I don’t want to get myself in trouble with my brethren. I don’t think there is much competition in clearing in terms of clearing of equity-listed options, or stocks. National Securities Clearing Corp.: all of the stock trades transacted on the major stock exchanges get cleared there in that one place. If you back to the 80s and certainly the 70s, the Chicago Stock Exchange Clearing Corp—back then it was Midwest Stock Exchange and Midwest Clearing Corporation/Depositary—they competed with the DTCC/NSCC.
At the end of the day clearing historically on the securities side—I’m not talking about the futures--has never really been one of those things that the Street allows competition in. The New York community, the New York Stock Exchange and ultimately NASDAQ had large volumes of the business. So you had Philadelphia Stock Exchange and clearing and depository and Midwest etc. playing in much smaller volumes. Maybe even in many ways being more creative in how they put clearing systems and processes together. But at the end of the day if you’re a clearing corp. what drives price down is volume. The more volume we get, the lower our costs to the user of the clearing house. So as New York got bigger, effectively what happened was their price was going down and as their price was going down, more and more business went into that clearing company. And over time it became the “cost-based” monopoly. The options are done that way.
You have the futures side of the business I think the lesson they tried to teach the securities world was that you don’t have one clearing corp. that clears for multiple exchanges. The [Chicago Mercantile Exchange] has its own clearing corp. Ergo that open interest is now the Merc’s and some new player can’t open and start trading against that open interest. The Merc won’t let them.
None of this am I saying in any shape or form is right or wrong. It is what it is. Smart, competitive people figure out how to play their game and that is what has evolved. You may have multiple clearing corps in futures; ICE has a clearing corp, Merc has a clearing corp, London has a clearing corp. But, they really don’t compete with each other. Merc and ICE might compete in certain products, but they clear separately so they’re not fungible. So they are really competing for the product when they do that.
It sounds like this latter model is the one that will dominate as OTC product is forced to clear.
My point is that there may be battles between Merc and ICE and all, the reality is each one is going to find its happy ground in terms of product base from the over the counter arena. It will become as standardized as it can, but still serve the needs of the over the counter market. Part of that need was they needed lack of standardization. Clients and users, they want to do “I’ve got a particular risk here and I want to cover that risk in the oil markets. How do I do that?” So there will still be more variability in my opinion and I think that’s how it is evolving in those products. They compete—who is going to get the oil business? Who is going to get the whatever business?
I will tell you we are working at how we get in to the over-the-counter equity index options business. That’s probably the obvious one for us of the things we feel we can get into.
DW: Given the nature of the shareholders and your business, are you looking for opportunities where they are not interested in clearing?
WL: We have a strong partnership with our exchanges. They love us. Part of the love is we do what they ask us to do.
So they think there is value in you looking at this and creating fungibility for something like this? Yes, because at the end of the day, let’s assume we find a way to do over-the-counter index options and that we garner some real business. What we have done is, even if it is not as standardized as the typical stuff we do, there is going to be more of standardization to it. What that is going to permit it seems to me is for exchanges to sit back and say, “Now we’ve got some flexibility in what standardization is. OCC is doing this for over the counter. We can offer product on our exchange and maybe tweak it a little bit here and a little bit there. We may gather some of that over the counter business out of that market into our own, because it’s standardized. It’s easy to do. They’ve got the lines in to our exchanges to execute derivative orders.”
I don’t want to suggest that exchanges think of this as the value. But, as they think about it, it’s hard to fight it and they look for opportunities. The exchanges are terrific partners for OCC. We wouldn’t be much of what we are without them because we don’t really have any products. Those are the guys that have to create ideas and products.
DW: Where are you with the idea of clearing OTC equity index options?
WL: We’re in the process of trying to obtain regulatory approval. Straightening out all our systems. What is the margin going to be? Who is going to do this? How are we going to do that? We are getting much, much closer to having resolved everything. We will need regulatory approval from the SEC to be able to do it.
DW: What is the track record of OCC in terms of adding new products?
WL: The world we’ve been in has been creating the listed product, not the over-the-counter product. This will be the first time we’re listing over-the-counter products. But, we’ve had a great track record in terms of supporting the creation of products. We opened the market in ‘73 with just calls. You need puts. We got that done in 75/76. Somewhere in the early-mid 80s we got in to the index business with the CBOE 100, which became the S&P complex at the CBOE. We clear transactions in stock loans—the lending and borrowing of stock comes through here.
We’re looking at other products that I can’t talk about.
Our general history has been pretty doggone good. We’re in the futures business. The VIX was something that didn’t start so good. But it sure found it’s place. That’s our stake in the futures arena. We clear futures for other exchanges.
DW: Where do you see the growth for OCC? What is going to drive that?
WL: All of the little things we do. Stock loans and we’ve other things that look like they could be really big for us going forward. But, in terms of the existing product base, it’s tied to some extent to the equity markets. If you tell me that you thought the equity markets were at their peak for a very long time to come, I’d probably change my prediction. I clearly don’t believe that. The people I talk to, they all contend that the S&P and stocks are at historic fair value. Absent some incidents, markets shouldn’t go down a lot and shouldn’t go up a lot, but as corporate profits grow and the world continues to recover, I think that bodes well. I don’t think the market goes forward and up without options going up. The two are so tied together. I have two sons who are option traders. They don’t do very much of just an option or just a stock. It’s in tandem. If you do these options, you’re going to hedge some of that with a stock position. The world has changed that way.
You don’t know what the market is going to do. But my general view is that as markets grow and volatility exists in the market place, it drives our business higher and higher.
We don’t drive volume. We react to volume. We’re fee-based on volume, but I don’t think we’re at the top. If you look at it the 90s where such an unbelievable period for the markets. We talk about 14 times earnings as being the historical standard. We were over 100 on a lot of stocks. It was crazy stuff. But we as we retracted from that our volume hasn’t fallen. Once you get to normal volatility in the market and we have a huge amount of public investors who are not in the market and they’re getting killed, they’ve got to hope we don’t have inflation. Having cash isn’t going to cover that. So all of that starts to feed back into a growing population of spenders and we’re off again.
DW: What’s your response to the SEC letter on OCC that was recently leaked?
WL: We got a letter. I don’t want to downplay the letter. It’s an important letter and we’re taking it seriously. We’re doing all the things that have to be done to make sure that the regulators are comfortable that we are doing things in a way that allows them to make sure we’re doing what we say we’re doing. It’s kind of like the Madoff situation. I think the regulators got called on the carpet. This guy was saying he was doing X, but he was doing Y and Y was illegal and Y was wrong. They’re not saying we are doing Y. What the regulators are saying is that we want to be in a position with the way you operate your business that you’re doing X, and not Y. We want to be able to come in and inspect and be sure of that. We need to do this stuff to get that thing moved in that direction. That’s a change from what they were doing. It’s an important change. My attitude about it is I understand why they have to do that. It’s important for them to do that. It’s important for us to have the proper reaction which is to fix it.
It’s sad someone felt the need to leak that. It’s a confidential document, but we move on. Nothing’s changed internally in here in terms of what we have to do and what we’re doing.
DW: At this point when you’re looking back, what are you most proud of?
WL: We built—and I do say we—something here, in the background with not a lot of public focus, a very strong capable, operational unit that supports the growth and business of the options markets. We got it right from almost the beginning. We made the right things happen. We made good choices over the years. I’m really proud of the people that have worked here and work here today. I think they get it. It’s been a culture of we’ve got to get stuff done for our customers—the exchanges and brokers. And if we don’t, we’re not fulfilling our mission.
DW: As a leader, how do you create that culture?
WL: I’ve been a lucky guy. I work for a company that there is no issue about doing the right thing. We don’t have a stock to price. I don’t have to meet with analysts every minute. I don’t have to worry about how do I keep the price up, how do I get it higher. I’m not saying it’s wrong for people to have to do that. That’s their environment.
Often internal audit activity draws the reaction, “Don’t rate me so low. Please don’t say those nasty things.” We want to know those things. We’ve always had the urge to know if something is not going properly in our operation, then how do we fix it? We want to know it’s wrong so we can take a look at it, agree it’s wrong and fix it. The culture of management here has been one of acting properly, setting an example—we don’t separate ourselves—Mike Cahill, the president who will become ceo when I leave, and I, every year in both of our cities, Chicago and Dallas, we get everyone together and talk about the year. This is what has gone well. This is what has gone poorly. This is where we have to pick up our game. Here is what we’re worried about at our level. You just keep pounding home. This is your livelihood. How can anyone in this room not want to do the best job we can and help this company be the most successful company it can be.
That meeting alone isn’t what does it. It’s living that life.
We built a lot of quality standards. We sat down in the early 80s and said “What do we have to do well? Today, tomorrow, next week, next month, next year, every time in order for our clients to go home and say I like doing business with that place.” Those guys get it. They make good things happen for us. We put those standards together and it’s kind of the flag we fly internally. Today, we get reviewed by our board as to how well we perform against those standards.
It’s not about us. It’s about the people having a choice about doing business with us or not. We’ve got to make sure we do the things well that they’re looking for every day.
That’s important to me. That’s what I think I am. That’s my legacy. I’m not some sort of cool guy chairman who runs around in limos at all the big banquets or what-have-you. That’s not Wayne-o.
DW: What’s the management team when you leave?
WL: The board decided to split my job in two. I’m chairman and ceo. Mike Cahill, who is now president and coo, will became president and ceo, and run the day-to-day business. They’ve hired Craig Donohue, the former Merc official, to come over here and be executive chairman of the board. He reports for duty Jan. 2. I think the board committees did a great job. It’s an era where you really have to dot your i’s and cross your t’s. I’m really comfortable that the place is in good hands as I leave.
DW: What do you plan on retirement?
WL: I’m 69 years old. I’ve been at this desk for 40 years plus. From the time I was a junior in high school, I’ve had a job of some form or another. I’d just really like to take some time for myself. I plan to take six months to a year, do a little traveling, play a little golf with my buddies. I’m a woodworker. I have my own woodshop and I make furniture and cabinets, mostly for family and friends. It’s very soothing. Very different from here.
Then I’ll start looking around. I’m not going to go looking for boards. I’ll probably be more focused in the charity area.