On October 19, 1987, the equity market experienced its largest one-day decline ever. The Dow Jones Industrial Average fell 22%, setting off a chain of events that took global equity markets lower.
This isn't the story of the Crash of 1987. This is the story of Blair Hull - the man who may have single-handedly steadied the market and in the process made 50% return on capital in a month.
In 1987, any stock market decline was unusual. In August, the DJIA was soaring, up 44% on the year. Then, as it does sometimes, the market pulled back. Over the next two months, it declined 17%.
That brings us to October 19 when the DJIA lost 22% of its value - the largest single-day decline in U.S. stock market history. (For more, check out Bloomberg's incredible interviews on the 1987 Crash.)
On Tuesday, October 20, the market was having trouble opening. Stocks were traded by specialists on the floor, who were responsible for matching prices of buyers and sellers. But no one knew what a fair price was. Markets traded higher at the open before the sell-off started.
The pits were overwhelmed by individual traders and institutions calling to sell. No one understood what was going on. And to compound the fear, there was legitimate uncertainty. On Tuesday, after the 22% decline Monday, rumors were surrounding what the exchanges and regulators were going to do. The Chicago Mercantile Exchange and Chicago Board Options Exchange halted trading. Only the Chicago Board of Trade was open. In New York, at the New York Stock Exchange, brokers were having trouble finding prices for stocks. In both places, the feeling on the floor was that trading would soon be halted.
Hull, who ran his own firm, told his traders that he wanted the firm to be long equities on the halt. He had an overwhelming sense that if there was a trading halt, it allow the market to stabilize and rethink its positioning.
At the CBOT, there was a futures contract called the Major Market Index, a basket of 20 blue-chip stocks. Of those, 17 of the stocks were overlapped with the Dow Jones Industrial Index. Blair recognized that it was a good substitute for the Dow.
There was a big seller in the pit who, as Hull recounts in the Bloomberg Article, was told to get out of his position regardless of the price:
“What will you buy 100 at?” a trader from Drexel [Burnham Lambert] asked. “285,” I said. And the Drexel trader said, “You own them.” I swallowed hard; it trades 287, 288. A few minutes later he asks, “Will you buy another 50 at 285?” And I said, “Yes.”
This was decision time; Hull took them and the market never looked back. Hull's buying caused brokers on other exchanges to demand that they open. He proved that there were buyers out there - and, just like that, confidence was restored.
What we know now is that the sell off was the result of portfolio insurance - a product that institutional traders used to hedge their risk. As stocks went lower, portfolio insurance would sell futures to offset losses on the underlying stocks. But it became a self-perpetuating cycle - where selling futures caused stocks to move lower, which then caused more pressure on futures.
All the market needed was a breather and someone to set a price. Hull did that and, in the process, may have stopped much deeper economic consequences.