Interactive brokers and option expiration

[failed_trad3r]

What happens when you are long ITM options but do not have the cash to cover the long stock positions?

According to my knowledge, ITM always auto-exercise, but what if you don't have the money for exercise?

 

[dragonman]

Quote from failed_trad3r:

What happens when you are long ITM options but do not have the cash to cover the long stock positions?

According to my knowledge, ITM always auto-exercise, but what if you don't have the money for exercise?

If suggest to verify it with them in advance if you don't want to have a "nice" meeting with their automatic liquidation algorithm.

 

[IB-AN]

Auto-exercise, or Exercise By Exception as it is often referred, is a clearinghouse process intended to ease the operational burden of clearing members having to inform the clearinghouse as to which options to exercise. In the case of securities options, OCC has a threshold by which all options which are in-the-money by at least $0.01 or more are exercised unless contrary instructions are provided by the broker.

The decision as to whether to allow a client to exercise an option without having the financial capacity to carry the underlying upon delivery is broker specific. However, consistent with the policy of not issuing margin calls, IB generally does not allow clients to exercise options if, after giving effect to the exercise, the client's account would not be in margin compliance.

As an extreme example of why this is not allowed, consider an account with nominal equity purchasing an at-the-money call option which is paid for in full and therefore requires no margin. Using GOOG as an example, the $540 weekly call option expiring tomorrow (Sept 2, 2011 ) closed today at $1.30, with the stock at $541.01. An account holding only $1,000 in cash could theoretically buy 5 of these call options and, were the final settlement price of the stock to end at $540.01 or more at expiration, be subject to the delivery of stock valued at approximately $270,000 with virtually no assets to meet the ensuing margin requirement. Were that exercise to be allowed, the stock would be liquidated upon the open given the margin deficiency, however, it's easy to see the uncollateralized exposure the broker is subject to if that stock opens down relative to the strike price.

To minimize exercise-related exposure, IB may take any one of the following actions at expiration:

1. Close out positions on the last day of trading;
2. Restrict the account to closing trades only;
3. Lapse (disallow exercise) some or all of the long contracts which are in-the-money; and/or
4. Immediately liquidate underlying positions subject to delivery effective with the option expiration.

As a general rule, you will receive an email/bulletin advising you if a review of your account indicates post-expiration exposure which exceeds your financial capacity. These notices are typically sent as early as 2-3 hours prior to the close, although it should be noted that advance notice cannot always be assured, particularly in those situations where the exposure does not surface until near or at the close as positions and prices change.

 

[jayre]

Quote from IB-AN:

Auto-exercise, or Exercise By Exception as it is often referred, is a clearinghouse process intended to ease the operational burden of clearing members having to inform the clearinghouse as to which options to exercise. In the case of securities options, OCC has a threshold by which all options which are in-the-money by at least $0.01 or more are exercised unless contrary instructions are provided by the broker.

The decision as to whether to allow a client to exercise an option without having the financial capacity to carry the underlying upon delivery is broker specific.
[/i]


Here is 3 simple steps IB can take to prevent these unneeded "option excersise related" liquidations.
1) Send e-mail the night before expiration alerting client that there is expiring options in the account which are close to the money (Other brokerages do that even when there is enough money in the account).
2) Have their computer program send a massage in middle of the expiring day to the clearing house that the option should "not" be excersised.
3)Send an e-mail to client at any point during the last day if the option goes in the money, & there is not enough money in clients account.

All of this can be easily done by IB real time super computer.
Any reason why IB would not put in a little effort to try avoiding liquidations??

 

[IB-AN]

I believe we are essentially saying the same thing albeit with some differences in timing and perhaps frequency. For example, it wouldn't be practical to provide the clearinghouse with mid-day instructions to lapse an option as the client may later sell that option or enter into a spread transaction where its exercise becomes relevant. Moreover its moneyness is subject to change.

There's also a balance which we attempt to strike between providing with meaningful communications when necessary and inundating clients with multiple communications in reaction to what are often rapidly changing risk profiles based upon their ongoing trade activity along with price changes. Our objective is to provide advance notice within a reasonable time frame of identifying the projected exposure so that the client can take the necessary steps on their own accord to address the situation.

 

[jayre]

Quote from IB-AN:

I believe we are essentially saying the same thing albeit with some differences in timing and perhaps frequency. For example, it wouldn't be practical to provide the clearinghouse with mid-day instructions to lapse an option as the client may later sell that option or enter into a spread transaction where its exercise becomes relevant. Moreover its moneyness is subject to change.

There's also a balance which we attempt to strike between providing with meaningful communications when necessary and inundating clients with multiple communications in reaction to what are often rapidly changing risk profiles based upon their ongoing trade activity along with price changes. Our objective is to provide advance notice within a reasonable time frame of identifying the projected exposure so that the client can take the necessary steps on their own accord to address the situation.

I don't think we are saying the same thing. I'm talking about a real time e-mail generted by ib computer (the same computer that starts doing liquidation in seconds), that would go out instantly to client when the option goes into the money, at any point during expiration date.
Obviosly the current system does not work. Too much liquidations related to option expiration found here on ET, I'm sure there is much more.

As for balance, trying to avoid liquidations is of MOST IMPORTANCE to any client and I'm sure people will appriciate getting an e-mail alerting them of that risk. However unfurtunately it seems that IB which invests so much in technology (updating tws 10 times a year etc.) invests very little to try to "preamptively" avoid liquidations. This has led me to speculate if ib & co is profiting in some way out of this liquidations.

I think the current system tha ib has of instant liquidation, but without any "reasonable" way how a client can protect himself against it(besides sitting by computer 24 hrs a day) would sooner or later start to backfire on IB.

 

[IB-AN]

I'm going to (politely) disagree with your recommendation and speculations. Sending a real-time email at expiration when an option goes in-the-money without consideration to the time of day or frequency at which it is sent would appear to add little value and is likely to be viewed as spam particularly since any given option could go in- our out-of-the-money numerous times throughout the day.

Based upon the feedback we receive from clients in the aggregate, the vast majority which comes directly rather than through public forums, this is not what they want. We have a variety of methods of informing clients when their accounts are at risk of liquidation whether due to current positions or projecting exercises as was the original question posed through this thread. In the case of current positions, this includes emails/TWS bulletins when one's margin cushion falls to 5%, as well as yellow, orange and red color coding of the TWS Account window to notify of approaching or existing margin deficiency. In the case of projected exercises, we operate as noted above.

 

[jayre]

Quote from IB-AN:

I'm going to (politely) disagree with your recommendation and speculations. Sending a real-time email at expiration when an option goes in-the-money without consideration to the time of day or frequency at which it is sent would appear to add little value and is likely to be viewed as spam particularly since any given option could go in- our out-of-the-money numerous times throughout the day.

Based upon the feedback we receive from clients in the aggregate, the vast majority which comes directly rather than through public forums, this is not what they want. We have a variety of methods of informing clients when their accounts are at risk of liquidation whether due to current positions or projecting exercises as was the original question posed through this thread. In the case of current positions, this includes emails/TWS bulletins when one's margin cushion falls to 5%, as well as yellow, orange and red color coding of the TWS Account window to notify of approaching or existing margin deficiency. In the case of projected exercises, we operate as noted above.

The 5% cushion is helpful when the market is stable. It only takes a volatile market with a few distorted quotes and the 5% cushion disappears in minutes (or seconds).
If the client is not sitting by his computer when he receives the 5% alert, by the time he gets to the computer, logs in, enter the security code, and wants to start doing something, the positions are gone already.
All the yellow, orange and red is good, “if you are sitting by the computer all that time with TWS open”. Otherwise there is no reasonable way how a client can protect himself against liquidation, and provides a huge disadvantage for IB clients vs other safe brokerages.(Yes there are some other safe brokerages)

 

[IB-AN]

If our default settings or visual indicators are not what one desires, they can set their own margin cushion alerts through the TWS. The alert message, once triggered, can be viewed via the TWS, email or SMS text message.

This feature can be found by selecting 'Alerts' from the Analytical Tools menu at the top of the screen and the click on the 'New' button. You then need to name your alert, click on the 'Add' button. specify your alert condition as "Margin Cushion" and then designate the % cushion at which you want to be notified. You can then specify the duration at which you want the alert to remain in effect and how you'd like to receive your messages (e.g. email).

Below are TWS screen shots which illustrate these steps.

 

[Options12]

Quote from IB-AN:

These notices are typically sent as early as 2-3 hours prior to the close, although it should be noted that advance notice cannot always be assured, particularly in those situations where the exposure does not surface until near or at the close as positions and prices change.

Is it that you send notice 2 - 3 hours before the close of the market or is it that you close the potentially under-margined positions 2 - 3 hours before the market close on expiration day?

I assume a notice precedes an auto liquidation, right? So what time do look-forward margin deficiency auto liquidations such as the situation you are describing begin each day?