How much time/size discretion do brokers have when hedging customer position?

[joederp]

First off, if relevant info is listed per exchange and reg authority site(s) just post links and I'll go digging

Let's say neither a broker nor its customers have pre-existing positions in a market e.g. WTI Crude. I buy one futures contract which the broker sells to me via in/outside clearing body to the exchange. They are now short WTI Crude...how much time are they legally allowed before hedging their own short exposure? 1 minute; 1 day; 1 week?

Far as 'style' of hedge, is it mandated to be an exact method or can they get creative? For example, I'd assume that any regulatory body, in this case the CFTC, is not going to state "make sure yer delta-neutral, bud" in their regs, so the broker could be doing a simple leg-into a Cal/Fly spread, or perhaps going into the options markets for some gamma/volga/vega-neutral far I/OTM acrobatics.

Anybody have knowledge, preferably 1st or 2nd hand, of what goes down for this part of the broker's daily ops?

 

[2rosy]

Let's say neither a broker nor its customers have pre-existing positions in a market e.g. WTI Crude. I buy one futures contract which the broker sells to me via in/outside clearing body to the exchange. They are now short WTI Crude...how much time are they legally allowed before hedging their own short exposure? 1 minute; 1 day; 1 week?

your assumption isn't how exchanges even work. If the broker took the other side of the trade it would always be first in the queue which would be great. futures brokers just clear and collect commision; they do not trade against customers

 

[Brighton]

You should probably start with some background reading on the formation and functions of exchanges > clearinghouses > futures commission merchants.

As for who's on the other side of your trade, you don't know, it doesn't matter, and they are not obligated to hedge their transaction. The counter party could be anyone - another small speculator, an index fund, a hedge fund, or a corporate descendant of John D. Rockefeller.

 

[joederp]

futures brokers just clear and collect commision; they do not trade against customers

Okay, so futures brokers are not obligated to offset a customer's position, it is a simple conduit as you and Brighton allude to.

U.S. stock brokers *may* be required to offset customer positions per U.S. regulations, then?

 

[2rosy]

Okay, so futures brokers are not obligated to offset a customer's position, it is a simple conduit as you and Brighton allude to.

U.S. stock brokers *may* be required to offset customer positions per U.S. regulations, then?

regular brokers dont take the other side of exchange traded instruments. you might be thinking of fx, bonds, rates, ...otc which is not retail

 

[joederp]

Okay, definitely got off on an errant foot with the assumption that a broker was counterparty...now that I take two seconds to think about it, it's obvious

But as a new example, and one that some of the more 'conspiratorial' types around ET have alluded to - say a customer of Interactive Brokers buys some AAPL call options from an exchange (CBOE, whatever..). Is their risk dept (either internally or subbed out to Timber Hill) required by law as a broker-dealer to come in and offset the customer's position under the regulatory auspices of 'balancing' such position?

 

[2rosy]

Okay, definitely got off on an errant foot with the assumption that a broker was counterparty...now that I take two seconds to think about it, it's obvious

But as a new example, and one that some of the more 'conspiratorial' types around ET have alluded to - say a customer of Interactive Brokers buys some AAPL call options from an exchange (CBOE, whatever..). Is their risk dept (either internally or subbed out to Timber Hill) required by law as a broker-dealer to come in and offset the customer's position under the regulatory auspices of 'balancing' such position?

those are 2 different entities. one's a broker the other marketmaker/trading firm. in your example, you could substitute timberhill with joederp. So if a customer buys some AAPL calls through IB which in turn buys the AAPL calls on the cboe from joederp, does joederp need to offset the short call position?

 

[SIUYA]

Is their risk dept (either internally or subbed out to Timber Hill) required by law as a broker-dealer to come in and offset the customer's position under the regulatory auspices of 'balancing' such position?

thats generally what margins are for, central exchanges and the ability to offset many accounts are ideally for.

 

[forexpolice]

Your assumptions could be right when considering brokers that uses DD execution. This is a platform where many bodies are involved including the broker. A DD broker is set up by financial experts like ever every other brokers and they can choose to hedge against you or not to.

 

[joederp]

those are 2 different entities. one's a broker the other marketmaker/trading firm. in your example, you could substitute timberhill with joederp. So if a customer buys some AAPL calls through IB which in turn buys the AAPL calls on the cboe from joederp, does joederp need to offset the short call position?

guess it depends on what type of entity joederp is, how many other entities of the same type as joederp are in that market, and how much of the market share they are, collectively...if they're all private llcs/partnerships/individuals, there's nowhere near the impetus to 'structure' a market versus Fed/Treasury-funded institutional traders.

BTW, rosy, thanks for correcting the errant statement which I made in the original example about the broker selling the contract to the buyer...certainly, it's the exchange that's counterparty. As to the broker's obligations (some/none) in what/how/when to hedge a customer's positions, above & beyond monitoring margin req'ts for its customer accounts, that's the answer I'm after. From what's been posted thus far, it appears that there is no legal obligation generally-speaking; it's merely a margin-watch. Using customer positions as collateral of-sorts for the broker's own, more involved book/portfolio, perhaps that's purely discretionary on their side.