Thomas Peterffy: INNOVATIVE BROKER
Thomas Peterffy, founder, chairman and CEO of Interactive Brokers, is considered one of the top innovators in the derivatives space. Here's how a Hungarian-born immigrant, and avid equestrian, became one of the most successful entrepreneurs in the industry, using technology and determination.
There are innovators, visionaries and hard workers in the entrepreneurial hall of fame. Thomas Peterffy is all three rolled into one.
Peterffy, chairman and CEO of Interactive Brokers Group (IB), has built one of the most successful market making and brokerage firms in the world. During the course of the past 30-plus years, he has challenged himself and others to think unconventionally about how derivatives should be traded and handled for customers. In almost Don Quixote fashion, Peterffy has battled established methods and exchange rules, bringing automation and technology into options and futures markets, making him one of the most influential change agents in the derivatives industry today.
It is not uncommon to hear entrepreneurs minimize or simplify the way they were able to make things happen for themselves. Often, successful men and women say they profited by doing something for which they had a passion. Such is the case for Peterffy, who says he doesn't have a methodology for coming up with new ideas and innovations. There simply isn't a five-step creative process for Peterffy.
"I never think about innovation," says Peterffy, who enjoys riding horses from the stables he maintains on his estate in Greenwich, Conn. "It just sort of comes as my thoughts wander. Ever since I was a child, I liked to daydream. As I got older, I often found myself daydreaming about things that have to do with work, such as the shape of the probable distribution of price changes, or how my fair values could be dynamic."
Trend setting
Peterffy was born in Budapest, Hungary, in 1944 during a World War II Russian bombing raid. In 1965, Peterffy saw little hope under the Soviet Union and defected to the United States. Speaking no English when he arrived, he ended up in New York, where he was able to connect with other Hungarians and used the engineering education he had begun in Budapest to land a job with a New York engineering firm. Later, the firm purchased a computer and asked for volunteers to learn programming for it. Peterffy stepped up and still jokes that learning computer programming was easier than learning English.
From there, Peterffy took a job at a computer consulting firm called Aranyi Associates, run by another Hungarian immigrant, Janos Aranyi. And that's where Peterffy got his first experience withWall Street. The firm developed financial software and Peterffy developed programs to help calculate stock and bond valuations.
From Aranyi, Peterffy moved to Mocatta Metals, a commodities trading firm run by psychiatrist-turnedtrader Henry Jarecki, where he learned about trading the markets.
In 1977, Peterffy left Mocatta and bought a seat on the American Stock Exchange (Amex) where he began to trade equity options. Stock options, first launched in 1973 with the Chicago Board Options Exchange (CBOE), were still a relatively new and evolving derivatives product. Peterffy recalls those days in the Amex options pit.
"When I first went down to the floor on the Amex it was literally a circus," Peterffy recalls. Amex options pits consisted of between three and 15 people and a specialist whose job was to keep track of who was bidding and offering on each option, how much and in what time-order each bid was made.
"It was, of course, physically impossible," Peterffy says. "The result was constant arguments, pecking-order issues, favors, bribes, and so on. After watching this for a few days, I naïvely proposed that traders be given computers where you could enter bids and offers. And the computer would match buyers and sellers in the proper order. Everybody hated the idea."
For Peterffy, that's when market reality hit. Specialists and floor traders didn't want order and efficiency. They profited from confusion and disorder. It's also when Peterffy went to work on an idea that would eventually change the way people traded stock options. Using his own options pricing formula, which he developed himself in 1971 for trading commodity options on futures, Peterffy applied it to stock options on the Amex floor. Because computers were not allowed, Peterffy brought his fair pricing sheet into the pits with him each day.
In 1978, Peterffy formed T.P. & Co., a trading firm that started with four other traders that used those fair value sheets to help trade options. By 1982, he created the market making firm Timber Hill and developed handheld computers for his traders to calculate fair values and keep track of trades.
Peterffy then looked to Chicago, where he planned to expand the computerized market making operations at CBOE. Unlike Amex, where he was able to get permission to bring computers onto the floor, he found stiff resistance to the idea in Chicago. He also tried to bring computer screens onto the New York Stock Exchange options floor, but was told to keep them back in the booths and away from the pits. Rather than give up, Peterffy designed a coding system showing large colored blocks on the screens to signal traders in the pits.
Another story involved rules that prevented traders from electronically entering orders into the NASDAQ dealing terminals. The rules stated that orders had to be entered through the keyboard, so Peterffy designed a system where computerdriven robotic "fingers" would type in the orders. If you don't believe it, Peterffy still has some of his inventions in his Greenwich office.
It wasn't until 1988 when CBOE allowed Timber Hill into the then fledgling S&P 500 options pits, with large computer screens directly connected to Peterffy's offices in New York. Timber Hill is credited for breathing life into the contract and, today, the S&P 500 options stands as the CBOE's top volume contract with 158 million contracts traded in 2007.
The firm both created and rode the wave of technology that has swept the equities and derivatives industries for more than a decade. In 1993, Peterffy created Interactive Brokers as a separate discount brokerage firm aimed at experienced retail traders and institutions.
IB also was a leader in creating a trading network to different exchanges so orders could get filled quickly. Not only that, but IB is also considered one of the pioneers in the development of smart order routing for customers, a computerized system that quickly checks the prices of a particular option for a customer and then sends it to the exchange with the best price. Today, smart order routing is relatively common among brokers, but IB's system is still believed to be the only one that matches pending orders in listed options among all of its customers. Peterffy's firm has also used its technology to bring lower pricing and drive down commissions in the industry.
IB was arguably the first and still remains one of the few firms to offer securities, derivatives, and forex trading in one customer account with a single-base currency. The so-called Universal Account, launched by IB in 2002, allows customers access to more than 70 different markets around the globe. The firm added access in February to the Mexican stock, futures and options market and Spanish stock market.
Its market making and brokerage units averaged 752,000 trades per day in 2007, representing 673 million options contracts, 83 million futures contracts and more than 47 billion shares of stock in 2007.
IB is also a force in the futures industry and is among the largest market makers in CME Group equity index and forex futures and options, as well as one of the biggest customer order providers to CME Group.
Going public
Last May, Peterffy sold 10 percent of IB in an initial public offering and continued to grow the company. Last year, the firm posted its best year ever as volatile markets brought in more volume and trading opportunities. Net revenues for 2007 totaled $1.46 billion, up from $1.25 billion a year earlier with the bulk of its $931 million in pre-tax earnings coming from its Timber Hill unit.
Like many company founders, Peterffy is adjusting to managing a publicly-traded company after running IB as a privately- held firm. On the one hand, Peterffy says it has made his company more disciplined in its business strategy. On the other, publicly-held firms are often looked at by Wall Street analysts with much shorter time horizons.
"Investors look at the business differently than I," Peterffy says. "I always thought about it going five years forward."
Publicly-held or not, Peterffy said he is committed to his style of running the firm.
"We are an entrepreneurial company and we intend to remain that way," he says.
The firm continues to grow and innovate through acquisitions and new products for its customers.
Last November, IB made its first acquisition ever with the purchase of FutureTrade Securities, which will help them expand faster into the hedge fund and institutional trading sectors. FutureTrade serves more than 200 institutional customers and has 40 software developers who have been integrated into the company's technology group.
The firm augmented its efforts to grow its institutional customer base with a new risk-management tool called IB Risk Navigator. The free technology allows clients to view their portfolio risk, and refreshes the data every 10 seconds and upon changes to the portfolio.
IB not only trades on exchanges, it has invested in them as well - the company is an original equity shareholder in the Boston Options Exchange (BOX) and equity partner in OneChicago, the single stock futures exchange.
BOX, launched in 2004, brought new changes to the options markets, such as the Price Improvement Period, which allowed market makers to compete and improve options prices in penny increments for customers. That innovation, driven in large part by IB, was strongly opposed by other options markets, but was later adopted by two of them. Peterffy also decided to buy a stake in OneChicago in 2006, the fledgling single stock futures exchange owned jointly by IB, CME Group and CBOE. Single stock futures have been hampered in large part by regulatory rules and an established stock loan business that has made marketing the product difficult. But it didn't stop Peterffy from buying into the exchange and promoting the product, even though many believe securities futures has a tough mountain to climb.
"We're going to climb it," he says. "Overcoming inertia is a slow process but you must stick with it - and we will. It's just like electronic trading used to be. Few people remember that the first electronic futures exchange in Bermuda in 1985 failed because of lack of interest. We were the only market maker."
Looking ahead
With a growing acceptance of exchange-traded derivatives around the globe and increasingly volatile markets, Peterffy says IB and exchanges are in good position.
"Much of the business that is currently conducted over the counter will migrate to the exchanges," Peterffy says. "Electronic exchanges will gain greater prominence around the world because of greater transparency and the elimination of counterparty risk." because of greater transparency and the elimination of counterparty risk, which is assumed by central clearing houses."
Peterffy believes the massive volume growth that has been occurring in the futures and options space will continue as access to exchanges continue to improve and open doors to more customers. Last year, the futures industry volumes grew about 26 percent while US equity options rose 41 percent.
"Growth will continue for the foreseeable future, especially internationally, as more people enter the derivatives space," Peterffy says. "When I started in the business, most people didn't know how to price options. Today, you can't get an MBA without taking a course on option theory."
Looking out five years at the industry landscape, Peterffy sees the exchange consolidation continuing.
"Some people think we'll end up with a few very large exchanges," Peterffy says. "Others believe there will be many smaller ones, which is more robust technologically and financially. I think there will be a few groups of exchanges tied together via common ownership. What is important is that we preserve the competitive environment and sufficiently incent these exchanges to introduce new products and services, so an ever-larger percentage of the global market can take advantage of the efficiencies and competitive pricing provided by the exchanges." |
