PUT options liquidated at worst possible prices

[stefan_777]

Quote from jimrockford:

Let me first explain it with cash-settled options, and then with physically settled options.

If you are trading a spread on American style, cash-settled options, then you face the following risk of extreme uncontrolled loss:

A strong market move puts the spread deep in the money at the close of trading. The short option leg is exercised, generating a huge loss. You take comfort in your long option leg, which will limit that loss, with profit left over to spare. It is, however, too late to exercise your long option leg on the same day, because you didn't receive notice of assignment on the short leg until after it was already too late for you to issue early exercise instructions (note this will always be the case). So you resolve to exercise the long option leg as soon as possible, which would be the following trading day. So you are perfectly safe, right? Wrong.

You wake up and learn that the market has gapped open violently in the opposite direction from yesterday's big move. It keeps going and never looks back. Your long option leg becomes worthless by the close. You issue exercise instructions, but you get no cash because your long option leg is now worthless. You are now stuck with the entire loss generated by the short leg.

But there is another thing that can go wrong. Suppose the loss generated by the short leg so severely reduces your account equity, that you are in violation of margin rules. The long option leg counterbalanced this loss by becoming extremely valuable, but because it is an option, its value DOES NOT count toward measuring your account equity or satisfying your margin obligations. The broker now has the right to liquidate your long option leg by selling it before you have a chance to exercise it. The broker wishes to do this in order to generate some cash, which would count toward your account equity and reduce your margin obligations. What if there is no reasonable bid at the time of sale? What if the bid is near zero? This scenario also sticks you with most or all of the loss generated by the short leg.

Here is another nightmare scenario, which applies to physically settled, American style options. You have incurred a massive loss on the short option leg, and you have been stuck with a long or short equity position by assignment of your short option leg, and you resolve to exercise your long option leg in 24 hours, so as to reverse your massive loss. But - oh no! This massive loss triggers a margin violation! Your long option leg is extremely valuable, but because it is an option, its value does not count toward measuring your account equity or satisfying your margin obligations. So, the broker has the right to liquidate your account, and your long option leg is sold at an unreasonably low price before you get a chance to exercise it, and once again, you are stuck with most or all of the loss generated by the short option leg.

A variation on that nightmare scenario might occur where your long option leg is not liquidated, but the long or short equity position resulting from your short leg's assignment is liquidated instead, because you don't have enough margin to carry that equity position. You are confident you will be OK, though, because you plan to exercise your long option leg in 24 hours. But oh no! By the time you get the proceeds from exercising your long option leg, they have dwindled to near zero, because the market moved hard and fast against your long option leg! And once again, you are stuck with most or all of the massive loss generated by the short option leg!

Here is another variation on that nightmare scenario, which can occur when you are using options in order to get a great deal of leverage, to benefit from price movements on notional underlying quantities so large you could never afford to swing them around as underlyings. Your long or short equity position is liquidated, but your long option leg is left intact, and the market does NOT move against your long leg before you can exercise it. This successful exercise results in a new long or short equity position. You resolve to play it safe by closing that equity position at tomorrow morning's open. But oh no! The market gaps hard and far against you, and because you were excessively leveraged, the gap wipes out your entire account!

Your worries apply only to spreads in American style cash settled, which the only viable contract of this type would be the OEX contract. The vast majority of cash settled options are European style index options (which are the only spreads allowed in cash accounts, and you know you can't rant against those anyway)

Debit put spreads in American style physical options, which are the vast majority of options available for equities (like the OP's SPY puts in question), are shielded from adverse price moves after early assignment, because the short option writer is given a long stock position at the given strike price during the night after assignment, and can close the position the next day without enough cash to bear the position, without breaking margin rules, as you've been corrected earlier by johnnyc.

If I get assigned on the short put of my bear put spread for an American physical, I get forced long at the strike price of that short put. If the market gaps up drastically the next day to make my long put OTM and un-exercisable, I'm still long the market at the lower strike price and obviously make money and can close the position at a profit maybe even higher than anticipated from the spread. If it gaps up but not through my long put, leaving it ITM, I can exercise the long put to flatten my account for the expected maximum profit of the spread. If after early assignment, the market keeps tanking, I'm forced long at the short strike price without violating any margin requirements, but the next day I can still exercise the long put which would be DITM to flatten the long position in the account, which causes the maximum profit on the spread.

In all three possible scenarios after early assignment outlined above, you make money.

Assignment is a GOOD thing for debit spreads in equity options.
You need to trade these before you make long winded rants about them.

 

[jimrockford]

Quote from stefan_777:

Your worries apply only to spreads in American style cash settled, which the only viable contract of this type would be the OEX contract. The vast majority of cash settled options are European style index options (which are the only spreads allowed in cash accounts, and you know you can't rant against those anyway)

Debit put spreads in American style physical options, which are the vast majority of options available for equities (like the OP's SPY puts in question), are shielded from adverse price moves after early assignment, because the short option writer is given a long stock position at the given strike price during the night after assignment, and can close the position the next day without enough cash to bear the position, without breaking margin rules, as you've been corrected earlier by johnnyc.

If I get assigned on the short put of my bear put spread for an American physical, I get forced long at the strike price of that short put. If the market gaps up drastically the next day to make my long put OTM and un-exercisable, I'm still long the market at the lower strike price and obviously make money and can close the position at a profit maybe even higher than anticipated from the spread. If it gaps up but not through my long put, leaving it ITM, I can exercise the long put to flatten my account for the expected maximum profit of the spread. If after early assignment, the market keeps tanking, I'm forced long at the short strike price without violating any margin requirements, but the next day I can still exercise the long put which would be DITM to flatten the long position in the account, which causes the maximum profit on the spread.

In all three possible scenarios after early assignment outlined above, you make money.

Assignment is a GOOD thing for debit spreads in equity options.
You need to trade these before you make long winded rants about them.

First, nobody disputes my nightmare scenarios as to American style, cash settled options, so this post will skip over them.

Second, I need to correct an error in one of my nightmare scenarios which you quoted. It is the first of the scenarios involving American style, physically settled options. Said scenario holds corrrect only if margin violations cause the broker to liquidate the long or short equity position resulting from assignment of the short option leg. I erroneously omitted that condition from that particular scenario.

Third, your denial of any possible nightmare scenarios, as to American style, physically settled option spreads, is simply incorrect. Your comments ignore the danger that a margin violation might cause the broker to liquidate the long or short equity position resulting from assignment of the short option leg. A trader can easily generate such a margin violation, for example, because the margin required for the long or short equity position is generally much greater than that required for the option spread leading to the equity position; and also because the loss resulting from the short option's assignment massively reduces or wipes out the account's equity, while the counterbalancing gain on the long option leg is not counted (see IB's website) for purposes of measuring account equity for margin purposes. Or such a margin violation can result from changes in other positions in the account, like the FX position which caused the disaster in your own account.

 

[stefan_777]

Quote from jimrockford:

First, nobody disputes my nightmare scenarios as to American style, cash settled options, so this post will skip over them.

Second, I need to correct an error in one of my nightmare scenarios which you quoted. It is the first of the scenarios involving American style, physically settled options. Said scenario holds corrrect only if margin violations cause the broker to liquidate the long or short equity position resulting from assignment of the short option leg. I erroneously omitted that condition from that particular scenario.

Third, your denial of any possible nightmare scenarios, as to American style, physically settled option spreads, is simply incorrect. Your comments ignore the danger that a margin violation might cause the broker to liquidate the long or short equity position resulting from assignment of the short option leg. A trader can easily generate such a margin violation, for example, because the margin required for the long or short equity position is generally much greater than that required for the option spread leading to the equity position; and also because the loss resulting from the short option's assignment massively reduces or wipes out the account's equity, while the counterbalancing gain on the long option leg is not counted (see IB's website) for purposes of measuring account equity for margin purposes. Or such a margin violation can result from changes in other positions in the account, like the FX position which caused the disaster in your own account.

Same-day substitution prevents any margin calls to the account assigned the shares. The assigned person or their broker simply offsets the long position with an exercise request the next trading day. Or closes the long at a larger than expected profit in the case of a gap up past the long strike the next trading day without any margin restrictions.

Your margin violations resulting from the assigned shares are fictitious. If they were factual, brokerages wouldn't be satisfied with the present amount they require to margin a debit spread.

So please, stop talking through your hat.

And of course a broker can liquidate spreads if other things interfere. But the spread in and of itself doesn't deserve to be liquidated, no matter how many "nightmare" situations you can dream of. Since we all figured there might be something else that interfered, if that officially turns out be the case, you can't take credit for it. It wouldn't be a groundbreaking discovery that you alone somehow predicted.

LOL

 

[johnnyc]

Quote from jimrockford:

Let me first explain it with cash-settled options, and then with physically settled options.



Here is another nightmare scenario, which applies to physically settled, American style options. You have incurred a massive loss on the short option leg, and you have been stuck with a long or short equity position by assignment of your short option leg, and you resolve to exercise your long option leg in 24 hours, so as to reverse your massive loss. But - oh no! This massive loss triggers a margin violation! Your long option leg is extremely valuable, but because it is an option, its value does not count toward measuring your account equity or satisfying your margin obligations. So, the broker has the right to liquidate your account, and your long option leg is sold at an unreasonably low price before you get a chance to exercise it, and once again, you are stuck with most or all of the loss generated by the short option leg.

A variation on that nightmare scenario might occur where your long option leg is not liquidated, but the long or short equity position resulting from your short leg's assignment is liquidated instead, because you don't have enough margin to carry that equity position. You are confident you will be OK, though, because you plan to exercise your long option leg in 24 hours. But oh no! By the time you get the proceeds from exercising your long option leg, they have dwindled to near zero, because the market moved hard and fast against your long option leg! And once again, you are stuck with most or all of the massive loss generated by the short option leg!

why would the broker liquidate the long option to meet the margin call and not exercise it for the client?

if you don't have sufficient margin to maintain the assigned long or short position and it's liquidated for a loss, how are you going to have sufficient margin to exercise the remaining long option? why would you want to exercise the long option rather than just sell it? No time or vol value left in it?

 

[MoreYummy]

Quote from Ghost of Cutten:

Ultimately, the main problem is that any auto-liquidation engine has the risk of liquidating off crazy quotes during a temporary market dislocation. Without human judgement, you risk auto-liquidating at these insane prices. At that point, either IB or the customer is at the mercy of exchange trade bust committees. Both IB and customer face much higher risk due to poor auto-liquidation.

If the auto liquidation has poor design, it needs improving - nice to know you are working on it, but more transparency would be good. If auto liquidation is inherently dangerous, then it needs a manual component. If you don't have enough staff for that, hire more. If it goes against your business model, then your choice is to either change your business model or to risk losing customer business. [/B]

What IBj suggests: IB is the only one making the judgement call, of course they dont want to close the position, and make unhappy customers come here to rant about it. If customer dont come here to rant about it, they are happy to close it ! They are making commission sooner too.

Also the only way not to get liquidated like this is not have more than 30% excessive margin, the only way to guaranteed it wont happen is 1) dont trade at all, 2) trade with someone else that can have Human brain or have a perfect designed risk system.

To the Original Poster: if you have any good outcome to it, let me know. I had similar situation a few years back, and they didnt care a cent. Let alone wasting same amount of money for lawyer to get the same amount of money back.
Even outcome if unpleasant, we might work something out of it.

Im sure there are more than few from IB in same situation, just they dont find each other yet.

thanks.

 

[hippie]

jimrockford, I dispute your nightmare scenerio:

Being assigned the short leg of an option near the low is not a problem if the long leg of the vertical spread remains.

If the security gaps up the next morning after the assignment, the assigned position would had also recovered! No real loss here.

There is absolutely no reason for IB to liquidate the vertical spreads as posted by somedudetrader in the first message.



Quote from jimrockford:

Let me first explain it with cash-settled options, and then with physically settled options.

If you are trading a spread on American style, cash-settled options, then you face the following risk of extreme uncontrolled loss:

A strong market move puts the spread deep in the money at the close of trading. The short option leg is exercised, generating a huge loss. You take comfort in your long option leg, which will limit that loss, with profit left over to spare. It is, however, too late to exercise your long option leg on the same day, because you didn't receive notice of assignment on the short leg until after it was already too late for you to issue early exercise instructions (note this will always be the case). So you resolve to exercise the long option leg as soon as possible, which would be the following trading day. So you are perfectly safe, right? Wrong.

You wake up and learn that the market has gapped open violently in the opposite direction from yesterday's big move. It keeps going and never looks back. Your long option leg becomes worthless by the close. You issue exercise instructions, but you get no cash because your long option leg is now worthless. You are now stuck with the entire loss generated by the short leg.

 

[jimrockford]

Quote from stefan_777:

Same-day substitution prevents any margin calls to the account assigned the shares. The assigned person or their broker simply offsets the long position with an exercise request the next trading day. Or closes the long at a larger than expected profit in the case of a gap up past the long strike the next trading day without any margin restrictions.

Your margin violations resulting from the assigned shares are fictitious. If they were factual, brokerages wouldn't be satisfied with the present amount they require to margin a debit spread.

So please, stop talking through your hat.

Your assumptions are false and dangerous. I know of specific actual cases contradicting your assertions, where people traded highly leveraged, American style exercise, physically settled option spreads, based on the same assumptions you are flogging. The assumptions turned out to be wrong in actual practice. Each person, in each of these cases, lacked enough margin to cover the long or short equity position assigned by the short option leg. Each account was liquidated in such a way as to deprive the person of the protection expected from the long option leg. Each person suffered massive unexpected losses from the short option leg, because the long option leg did not protect him as expected.

One of these cases involved a broker's customer service rep, who gave the customer advice matching your own. The advice turned out to be wrong, and resulted in liquidation of the account with massive losses.

I am reporting this information secondhand, based on information from other traders. I never had this experience in my own account, because I have always been careful to avoid margin violations of any kind.

Quote from stefan_777:

And of course a broker can liquidate spreads if other things interfere. But the spread in and of itself doesn't deserve to be liquidated, no matter how many "nightmare" situations you can dream of. Since we all figured there might be something else that interfered, if that officially turns out be the case, you can't take credit for it. It wouldn't be a groundbreaking discovery that you alone somehow predicted.


LOL

The truth is that I was alone in arguing my correct diagnosis that the OP's other, undislcosed positions triggered margin violations and caused his put spreads to be liquidated. Your posts ranted and raved that I was wrong, and were filled with outrageously offensive personal attacks against myself and others who correctly noted your numerous errors. The broker later revealed that I was right and you were wrong. You should be embarassed, ashamed of yourself, and apologizing for your childish conduct in this thread, but you are too weak to admit error. It is for this reason that you are now trying to rewrite this thread's history. Anybody who reads the entire thread can see for himself that you have zero credibility, that nearly all of your comments are wrong, and that people who rely on your assertions do so at the risk of personal bankruptcy. I wish you would go away, so that everybody else can focus on the topic.

 

[jimrockford]

Quote from johnnyc:

why would the broker liquidate the long option to meet the margin call and not exercise it for the client?

I don't know. I suspect that perhaps, in the case of a long equity position, resulting from assignment of a short put, exercising the long put to reduce a margin deficiency might risk triggering disciplinary action against the broker. I suspect that if it is against the law, it is because there are risks which are not immediately apparent to retail idiots like us. Perhaps some brokers will allow it, even if it is against the law. I suspect that in the case of a short equity position, resulting from assignment of a short call, some brokers may allow exercise of the long call on a same day substitution basis, and that the law does permit this margin treatment for call spreads, but that other brokers have policies refusing to allow it. I suspect that they refuse to allow it because there are risks not immediately apparent to retail idiots like us. I also don't know if it is legal, under any circumstances, for a broker to exercise an American style option, as part of a margin liquidation, without first obtaining exercise instructions from the customer. Does anybody know?

Quote from johnnyc:

if you don't have sufficient margin to maintain the assigned long or short position and it's liquidated for a loss, how are you going to have sufficient margin to exercise the remaining long option?

I'm not at all sure that there is any rule requiring a broker to impose margin requirements upon the exercise of a profitable option when combined with liquidation of the position resulting from the exercise. I suspect that any such margin requirement would be imposed by the individual broker's policies. My nightmare scenarios did not depend upon the existence of any such margin requirement. If such requirements are imposed, either by law or by your individual broker, then they provide yet another category of nightmare scenarios, in the event that you can't meet that additional margin requirement.

If an equity position is liquidated at a loss, this liquidation might still reduce or eliminate the account's margin deficiency. Perhaps this reduction would go far enough to meet any margin requirement imposed upon exercise of the long option (if there is such a requirement). But because the equity position has been liquidated, the long option is not hedged and its gain is not locked in, and the market could move hard against the long option and render it worthless before there is any chance to exercise it, and so, this would still be a nightmare scenario. It is a nightmare because you can exercise the long option leg, but it becomes worthless before you have a chance to do so.

Quote from johnnyc:

why would you want to exercise the long option rather than just sell it? No time or vol value left in it?

Sometimes markets are closed by unexpected disruptions, and it is not possible to sell. Remember the 9/11 World Trade Center terrorist attack? Sometimes markets are operating and open for business, but there is no bid for your option or other security. Sometimes there is a bid, but no reasonable bid. Have you already forgotten what happened last week? Have you already forgotten that in this very thread, the OP's long options were liquidated for far less than their intrinsic value? Ask yourself: why did IB liquidate the OP's long options for prices far less than their intrinsic value?

The right to exercise an option spread's long leg is a safety valve protecting the option spread trader from extreme losses, particularly when it is not possible to sell the long leg for a reasonable price. It is wise to protect exercise rights, by avoiding margin liquidations which might jeopardize them.

 

[jimrockford]

Quote from hippie:

jimrockford, I dispute your nightmare scenerio:

Being assigned the short leg of an option near the low is not a problem if the long leg of the vertical spread remains.

If the security gaps up the next morning after the assignment, the assigned position would had also recovered! No real loss here.

.

You didn't read my nightmare scenarios carefully. You quoted some of my scenarios which apply only to cash-settled options, but your criticism applies only to physically settled options. Options can't be both cash-settled and physically settled at the same time. You should read my scenarios applying to physically settled options, if you want to talk about physically settled options. It seems you are confused.

My scenarios for physically settled options involve situations where the assigned equity position is liquidated because the account lacks margin required for that position. The absence of a long (short) equity position deprives the trader of any benefit from upward (downward) movements in the underlying, while leaving the long option leg unhedged and exposed to the danger of becoming worthless before that value can be realized by exercise or liquidation.

Another danger is that margin violations will cause the broker to liquidate the long option at an unfavorable price, as happened in the case giving rise to this thread.

It is very important to avoid margin violations and liquidations when trading options. If you don't observe this precaution, you can sustain massive losses.

Quote from hippie:

There is absolutely no reason for IB to liquidate the vertical spreads as posted by somedudetrader in the first message.


[/B]

.

IB's reason, for that liquidation, was to protect IB from the danger of being held responsible for paying somedudetrader's gambling debts. If IB did not impose and enforce margin requirements, then IB would be held responsible to pay huge gambling debts created by customers like somedudetrader, who use excessive leverage, don't understand the risks they are taking, and then try to stick IB with the bill. IB's resulting losses would then increase IB's operating costs, and this would tend to increase the commissions which IB charges us, and to decrease the funds available for maintaining and improving the quality of service IB provides us, and might subject IB to disciplinary action. If IB found itself unable to cover large losses simultaneously created by a large number of such customers, for example, in a market crash, then the law could require that such losses be covered by taking assets from the accounts of responsible careful customers, who did not contribute to the excessive risks. IB liquidated somedudetrader's account, in order to avoid these risks. It doesn't make sense to you, because you don't understand the risks.

Remember that somedudetrader was holding positions other than just his option spreads, and that these other positions triggered his margin violation, and thereby created a need to liquidate the option spreads in order to limit the losses created by the other positions.

 

[stefan_777]

What a kook. The only person who really tried to dispute me was blackjack007 and that was over trivial semantics that I corrected him on in the end. And some other guy who thought I was extrapolating, but it turned out he missed my first posts stating that my opinions were conditional on the the validity of the OP's story.

Since I have an account with them, here's what optionsxpress says about assigned positions at expiration. It applies to assigned positions on spreads before expiration of course.

Expiration Process and Risks
[...]
-Exercises and assignments appear on Sunday: Your assignments and exercises will be processed and visible in your account on the Sunday following expiration. If you have questions about positions that appear in your account, please email us during non-business hours and indicate that your question is related to expiration.
-You may need to close positions on Monday (or next business day after expiration): You may be required to take action on any positions that would create margin or risk issues on the next trading day. You are responsible for trading the resulting position or requesting that the position be offset by exercising any unexpired long options of the same class. In the event that you fail to take action, your account may receive a margin call or we may be required to close or liquidate positions at your risk.

Obviously any broker will give you time to flatten the assigned shares at a profit if you put in the exercise request or simply sell the long shares along with the profitable long option first thing in the morning at maximum profit, you moron. Which is what a dumb auto liquidating broker would do anyway. You're just proving you know nothing about this.

Your shoddy anecdotes are probably stories of dunces who are terrified of margin, sat on their hands, and didn't know what to do after assignment, and ultimately what the heck they were doing in the first place, just like you.

You must buy your koolaid in bulk.

Will somebody please come in and set this guy straight?
For me, it's like talking to a wall.