Insufficient margin to exercise ITM options - what happens?

[d0rian]

Encountered this for the first time on Friday (expiration day) around 3pm: IB's system rejected my attempts to exercise ITM calls, saying that I didn't have sufficient margin...(presumably because even though I had the cash required to buy the underlying shares, doing so would have left me in a non-compliant margin position.) I ultimately closed them by selling the long positions on the open market, but had to take like 5 cents below intrinsic b/c that's all I could get from MM.

Would rather have just let them expire and get auto-exercised, but I was uncertain about just what would happen in that scenario: their system rejected my attempts to exercise them manually at 3pm, so wouldn't the same restriction apply when the system tries to auto-exercise them after close? In researching the issue, I found something troubling on a different broker (OptionHouse)'s policies page:

"Accounts with insufficient equity on hand prior to exercise or assignment are subject to undue risk as a result of an adverse price change in the underlying security upon delivery. To protect against the excessive risk of an adverse movement in the underlying security, OptionsHouse may intervene and manage the risk on your behalf. Such intervention may include closing out existing positions, buying or selling stock against expected exercises or assignments, or entering “Do Not Exercise” instructions for positions expiring in-the-money."​

That seems to describe exactly what I'm concerned about: that a brokerage can simply deny you the ITM value(!?) Yes, it's client's responsibility to manage margin but that seems really heavy-handed...is that standard practice everywhere (IB in particular, if anyone knows)?

 

[Robert Morse]

If you got a margin call the next trading day, could you meet it?

 

[d0rian]

If you got a margin call the next trading day, could you meet it?

Glad you asked this, since it fed into a related / follow-up Q I had. In this particular scenario, YES I would have been more than fine come Monday morning, because I had several short positions that were expiring as well. And even though they were very far OTM, they still -- as of Friday afternoon -- were responsible for a substantial margin 'hold' on my account. So I wondered just WHEN the margin amount of expiring short positions gets 'released' to my account (some time on Friday, or Saturday presumably?)...and whether there's an important 'sequencing' issue: e.g. if the margin hold falls off my account BEFORE the system attempts to auto-exercise my ITM calls, everything's A-OK...but if system tries to exercise my ITM calls before margin from expiring short positions comes off, could there be a problem? Seems like that question should be immaterial since as you point out, come Monday morning my margin situation would be fine. But would be problematic if system wasn't sophisticated enough to take that into account.

 

[JackRab]

Hmm.. that is concerning... @d0rian have you checked with IB? Go on a chat with them... I'm quite interested to hear what they do...

I always thought they would exercise and then do a margin call next day. If not met, market sell the stock (which is better than market sell the calls).

 

[Robert Morse]

Margin gets released overnight after expiration. If expiration is Friday, you will see your new requirement Monday morning. If expiration is Wednesday, you will see it thursday morning.

Is this a Reg-t or PM account?

The reality is that they can't man their margin department to interact with 50,000 wires and margin calls after expiration. So, they set up their system to prevent margin calls and minimize expiration risk to them.

 

[d0rian]

Is this a Reg-t or PM account?

Reg-T.

Margin gets released overnight after expiration. If expiration is Friday, you will see your new requirement Monday morning. If expiration is Wednesday, you will see it thursday morning.

Right...but any idea about whether (a) the auto-exercise of ITM options happens before or after (b) the release of margin associated with expiring OTM short positions?

That's what had me concerned since if the system tries to do (a) prior to (b), it seems like the auto-exercise could be rejected (just like it was rejected when I tried to do it manually at 3pm on Friday). As I wrote above, the sequencing SHOULD be moot because the margin situation will be fine come the Monday open; but I don't know how sophisticated / forward-looking IB's auto-exercise system is and whether it might just reject the exercise outright...or whether it's 'smart' enough to realize "oh, he'll technically be non-compliant for a while on Friday evening, but a huge chunk of margin will get released before Monday open, so we'll over-ride the margin limit that would ordinarily prevent him from exercising, like it did at 3pm Friday, because all will be well before the market opens again."

 

[Sig]

Reg-T.



Right...but any idea about whether (a) the auto-exercise of ITM options happens before or after (b) the release of margin associated with expiring OTM short positions?

That's what had me concerned since if the system tries to do (a) prior to (b), it seems like the auto-exercise could be rejected (just like it was rejected when I tried to do it manually at 3pm on Friday). As I wrote above, the sequencing SHOULD be moot because the margin situation will be fine come the Monday open; but I don't know how sophisticated / forward-looking IB's auto-exercise system is and whether it might just reject the exercise outright...or whether it's 'smart' enough to realize "oh, he'll technically be non-compliant for a while on Friday evening, but a huge chunk of margin will get released before Monday open, so we'll over-ride the margin limit that would ordinarily prevent him from exercising, like it did at 3pm Friday, because all will be well before the market opens again."

You're actually very lucky they didn't autoliquidate your options, that is their published and usually followed tactic in that situation and they can do so even the day before expiration if they think you'll be ITM on expiration. IB doesn't do margin calls, they do auto liquidations, with market orders that may not get you anywhere close to the price you would have gotten with an intelligent limit order. Don't ever hold an option position within 2 days of expiration at IB unless you have enough margin now to take delivery of the underlying.

 

[JackRab]

@IB-AN can you shed some light on this?

I know options will be auto-exercised/assigned but what happens if pre-expiry there isn't enough cash to fulfill margin? Does IB wait until the next trading day after expiry to either give a margin call or liquidate the stock position acquired through expiration?

Thanks JR

 

[d0rian]

You're actually very lucky they didn't autoliquidate your options, that is their published and usually followed tactic in that situation and they can do so even the day before expiration if they think you'll be ITM on expiration. IB doesn't do margin calls, they do auto liquidations, with market orders that may not get you anywhere close to the price you would have gotten with an intelligent limit order. Don't ever hold an option position within 2 days of expiration at IB unless you have enough margin now to take delivery of the underlying.

I'm not sure this is true; where did you get this info from? After poking around more on IB's website, I found this policy which appears to speak directly to the Q I was asking:

"You should review your positions prior to expiration to determine whether you have adequate equity in your account to exercise your options. You should also determine whether you have adequate equity in the account if an in-the-money short option position is assigned to your account. You should also be aware that short options positions may be exercised against you by the long holder even if the option is out-of-the-money.

If you anticipate that you will be unable to meet the margin requirement on a stock delivery resulting from an option exercise or assignment, you should either close positions or deposit additional funds to your account to meet the anticipated post-delivery margin requirement.

If an option exercise or assignment results in the delivery of a long or short stock position and the account holder does not maintain sufficient equity to meet the ensuing margin requirement, IB may liquidate positions to restore margin compliance. While IB retains the right to liquidate at any time in such situations, liquidations involving U.S. security positions will typically begin at approximately 9:40 AM ET as of the business day following expiration."
​

So if I'm reading correctly, it seems like they WILL still auto-exercise your ITM options, even if you don't technically have sufficient margin to do so, but will then liquidate positions starting the first chance they get (9:40a next trading day). If that's correct, then it seems like the 'sequencing' issue I asked earlier ITT is moot and there's no scenario where I'd somehow 'forfeit' the ITM portion of a long option position at expiry because of any margin insufficiency(?) Would be nice if forum IB rep would confirm as much...

 

[Sig]

I'm not sure this is true; where did you get this info from? After poking around more on IB's website, I found this policy which appears to speak directly to the Q I was asking:

"You should review your positions prior to expiration to determine whether you have adequate equity in your account to exercise your options. You should also determine whether you have adequate equity in the account if an in-the-money short option position is assigned to your account. You should also be aware that short options positions may be exercised against you by the long holder even if the option is out-of-the-money.

If you anticipate that you will be unable to meet the margin requirement on a stock delivery resulting from an option exercise or assignment, you should either close positions or deposit additional funds to your account to meet the anticipated post-delivery margin requirement.

If an option exercise or assignment results in the delivery of a long or short stock position and the account holder does not maintain sufficient equity to meet the ensuing margin requirement, IB may liquidate positions to restore margin compliance. While IB retains the right to liquidate at any time in such situations, liquidations involving U.S. security positions will typically begin at approximately 9:40 AM ET as of the business day following expiration."
​

So if I'm reading correctly, it seems like they WILL still auto-exercise your ITM options, even if you don't technically have sufficient margin to do so, but will then liquidate positions starting the first chance they get (9:40a next trading day). If that's correct, then it seems like the 'sequencing' issue I asked earlier ITT is moot and there's no scenario where I'd somehow 'forfeit' the ITM portion of a long option position at expiry because of any margin insufficiency(?) Would be nice if forum IB rep would confirm as much...

If you search the threads here you'll find enough reports of IB actually auto-liquidating options positions the day of expiration that you can be fairly certain it's what they do in practice.
I've certainly fallen victim to this myself, in my case the day before expiration, so there's one data point. If you read enough threads you'll also find that IB reps are seldom forthcoming about their many customer unfriendly "features" and sometimes downright dishonest, out of either ignorance or malice no one is sure.