PUT options liquidated at worst possible prices

[jimrockford]

Stefan_777,

You are once again not accurately describing my statements.

Quote from stefan_777:

jim rockford,

Please provide references backing up why a broker can liquidate a spread that is in good standing within initial and maintenance margin, based on these special assignment margin risks (extreme dangers) you're talking about.

I don't think, and I never said, that an account complying with margin rules should be liquidated. You misunderstood me on this point. I suggested that the OP's account might have violated margin rules in ways he did not understand, and that these violations might have justified or necessitated at least partial liquidation of his account.

You also misunderstood my discussion of assignment risks. I did not raise them as an excuse for liquidating an account in compliance with margin rules. I discussed assignment risks in order to help explain why those margin rules were adopted by the federal government, and why additional margin rules were adopted by IB.

Quote from stefan_777:


IB and other brokers require the cash account holder to hold the full amount of cash to pay for a potential assignment of the short puts. This is what they mean by paying the put strike price. Why in the case of a cash account would someone ever have to be liquidated if they have enough cash to cover the worst possible event, which is satisfactory to IB, american style physically settled or not?

In a cash account, they won't let you short a "naked" put unless you have enough cash to hold it till expiration and be able to pay for either the physical or cash delivery in full once assigned.

Let's assume, hypothetically, that an IB customer has a cash account, and that he initially met the margin requirements for entering his put spreads in a cash account. It is possible that subsequent events involving the account's other positions, such as commodities futures, securities futures, FX, etc., might reduce the account's cash sufficiently so that the account no longer has enough cash to support the put spreads. This would lead to a partial or total auto-liquidation within minutes.

Note that the changes in the put option prices would NOT reduce the account's cash balance, and so would NOT trigger the initial liquidation. The trigger would come from losses on positions other than the put spreads, even though this might result in partial or total liquidation of the put spreads.

 

[FanOfFridays]

ATTICUS!!!!

Please, man. Can you not put an end to all this debate that's going on between these guys? It is unbelievable to me that someone hasn't weighed in here with a piece of informed guidance on this issue! Is it really that nebulous? Is there really not just a simple answer to all these questions?

What's the actual story? Is there any such thing as an options spread that limits risk for the holder? My whole understanding of the options world was that you could construct a position which would limit your losses under any circumstances including the morning California gets hit by The Big One and sinks into the ocean, or Tel Aviv gets a 4 kiloton warhead into downtown. Is that true or isn't it? If it's true, was the position the OP described one of them?

 

[noddyboy]

Good points are made but I think ib is at fault. They could always liquidate if the options are exercised which is what happened with etrade. Is there some risk to the firm? Yes, but IMO more risk if they keep using market orders to liquidate the way they currently do anyway. I am not saying that they shouldn't liquidate under any circumstances that market doesn't support their liquidation. In fact they could have caused the crash.

 

[stefan_777]

Quote from jimrockford:


Let's assume, hypothetically, that an IB customer has a cash account, and that he initially met the margin requirements for entering his put spreads in a cash account. It is possible that subsequent events involving the account's other positions, such as commodities futures, securities futures, FX, etc., might reduce the account's cash sufficiently so that the account no longer has enough cash to support the put spreads. This would lead to a partial or total auto-liquidation within minutes.

Note that the changes in the put option prices would NOT reduce the account's cash balance, and so would NOT trigger the initial liquidation. The trigger would come from losses on positions other than the put spreads, even though this might result in partial or total liquidation of the put spreads.

Well if your key premise depends on the OP having hidden positions going against him substantially, what difference does it make whether he has a cash or margin account?

In cash accounts, IB restricts the cash that is securing the short put (As you've quoted before). To affect the spread or short put position, he would need catastrophic losses in the hidden futures/fx positions in the cash account that were not caught by IB's immediate auto liquidation FIRST, and would have had to lose more than the cash he used to aquire them. That would be a huge stretch given the information we have from OP.

None of your explanations are useful to the OP's scenario. They're just written out to somehow deflect the blame to the customer by speculating he had other losing positions going and didn't understand how that affected his margin...

I suggested that the OP's account might have violated margin rules in ways he did not understand, and that these violations might have justified or necessitated at least partial liquidation of his account.

 

[johnnyc]

Quote from jimrockford:

One of the major mistakes, made throughout this thread and throughout retail options trading, is to assume that the long leg of a put spread always limits potential losses from the short leg. This does not actually hold true in all situations. It is reasonable for a broker to liquidate a put spread, including even a debit put spread, if it involves American style options in a cash or margin account. This is because such put spreads do create a risk of extreme and uncontrolled losses, through often overlooked mechanisms.

Suppose, for example, that the put options are like those held by the OP: American style with physical settlement. Suppose, further, that the short leg is exercised prior to expiration, so that the strike price of the short option is debited from the account, and long stock is put into the account. If the account has sufficient margin to hold onto the long stock, then the following day, or on any subsequent day, the long put can be exercised to limit any loss generated by the short put.

But now suppose that the account lacks enough margin to hold onto the long stock combined with its protective (long) put. This can happen in a cash account or in a margin account, for example, when values of other positions unexpectedly decline (like in a crash). It can also happen in a margin account, which did have enough margin to cover the put spread, but never had enough to cover the long stock with protective put. The broker can then liquidate the long stock and/or protective long put in a matter of minutes. IB's policies, as announced on its website, do warn and require that such liquidation will occur within minutes. Automatically.

The long protective put would not, in a cash account, be of any help in reducing the margin required to hold long stock. It would help in a margin account, because then the long stock and long put can be considered a protective put position, requiring less margin than long stock; but in an IB cash account, protective put positions are ignored, and require exactly the same margin as long stock. Either way, in a cash or in a margin account, a danger exists that there will not be enought margin to cover the long stock received by assignment of the short put, either with or without the protective long put.

The account's inability to hold the long stock would make it impossible to exercise the physically settled long put. The only alternative would be to sell the long put. It might, however, be temporarily or permanently impossible to sell the long put for a reasonable price, in the event of a market crash or other dislocation. The customer might not be able to realize the long put's value before the underlying soars and erases the long put's value. If the only way to realize the long put's value is to exercise it, but the customer lacks the margin required to perform the exercise, then the long put can entirely fail to limit the losses caused by the short put.

Another such nightmare scenario can occur if the options are American style and cash settled. If the short option is assigned, then its strike price will be debited from the account after the market close. The customer now plans to exercise his long put, in order to limit the loss created by the short put. But he won't be able to do this until the close on the trading day after the day the short put was assigned. This one day delay can be fatal to the customer. The underlying stock or other quantity might soar between the time the short put is assigned, and the time the long put can be exercised. This could destroy the long put's value, so that it does nothing to limit the loss imposed by the short put.

One possible way to limit this problem would be for the customer to purchase the underlying stock at the open the day after assignment of the short position. The customer could hold that position all day, sell at the close, and then exercise his long (cash-settled) put. But there are three scenarios in which this won't work. If the customer lacks sufficient margin to purchase the underlying, then this strategy won't work. OR if the customer does have enough margin, but fails to use it because of stupidity, communication breakdown, negligence, or some other problem. OR if the customer does have enough margin, but the underlying gaps to a high opening price which destroys the long put's value, then again, the strategy won't work.

Question: Is there another nightmare scenario, which can occur involving physically settled European options? Suppose a put spread expires deep in the money. The long put must be exercised in order to limit the loss created by the inevitable assignment of the short put. This would require a long stock position to be added to the account by the short put's assignment, and then debited away by the long put's exercise on the same night at expiration. BUT can the broker legally do this, if the account lacks sufficient margin to support the long stock position (with or without protective put)? Can a broker do this by providing a quickie margin loan, even if the account is a cash account? If a broker is permitted to do this, can the broker be required to do it?

But getting back to the case at hand, the OP was trading SPY puts, which are American style, so that there were scenarios in which the long put leg would fail to limit extreme and uncontrolled losses generated by the short put leg. So there are circumstances in which it might make sense for a broker to liquidate the OP's put spreads. These might involve, for example, violation of IB's Gross Position Value margin rule in a cash or margin account (see IB's website). Or they might involve failure to meet the requirements for holding naked short puts in a cash account, since put spreads are not recognized by IB's liquidation rules for a cash account.

FINRA rule 2520 states that the only spreads allowed in cash account are European Style cash settled.

If the put spread owner is assigned on the short leg, he'll end up long the underlying stock can either liquidate the stock to close out the assigned position or exercise his long put to close out his assigned position. Both are closing transactions and there is no Reg T margin requirement on a closing transaction.

The position by itself was fully hedged and should not have been liquidated. If the account had other positions that required margin and fell below the margin requirements for these other positions then the liquidation could possibly be justified.

 

[u21c3f6]

Quote from stefan_777:

Well if your key premise depends on the OP having hidden positions going against him substantially, what difference does it make whether he has a cash or margin account?

My guess.

A cash and a margin account have different requirements. In a cash account, the short position is not covered by the long position. I believe he might in fact have a cash account. It was also mentioned that it was in CDN. If his account was marked to market in USD, a fluctuation could have reduced his cash requirement and trigger a liquidation. Of course, the long position was sold first in an attempt to raise cash and if that didn't raise enough cash, then the short positions would be liquidated.

I don't know if this is what happened but I do believe that this is what could happen. Joe.

 

[sprstpd]

Quote from noddyboy:

Good points are made but I think ib is at fault. They could always liquidate if the options are exercised which is what happened with etrade. Is there some risk to the firm? Yes, but IMO more risk if they keep using market orders to liquidate the way they currently do anyway. I am not saying that they shouldn't liquidate under any circumstances that market doesn't support their liquidation. In fact they could have caused the crash.

But the point of the auto-liquidator is not to protect the idiot on margin, it is to protect all the non-idiots not on margin. And the reason I am comfortable keeping my cash at IB is that they will liquidate positions first and ask questions second. In this particular case, we still don't know enough information to make any conclusions.

 

[zdreg]

Quote from sprstpd:

But the point of the auto-liquidator is not to protect the idiot on margin, it is to protect all the non-idiots not on margin. And the reason I am comfortable keeping my cash at IB is that they will liquidate positions first and ask questions second. In this particular case, we still don't know enough information to make any conclusions.

there are traders who make judicious use of margin. the auto-liquidator protects them also.

 

[RichardRimes]

Rockford you have to be the single largest IB apologist on these boards. sheesh

Theoretically you are correct in that sometimes you actually can lose MORE money on a debit spread than the price you paid for it. I have WHEN I have tried to leg out of the position.

That is why this dude lost so much money...the auto liquidation process LEGGED out of the spread. The WHY is the question. If for some reason the short puts were assigned he most likely didn't have the cash to pony up (to pay for the assigned stock)and created a margin issue so the long puts were sold as well as the assigned spy stock...all at prices that created a bigger loss than the original debt. That SUCKS.

That is a good reason to stick to the SPX even though you get screwed by the MM's. If this had been a debit spread in the SPX he would not have been assigned the short puts.

 

[traderlux]

....here is your bone...irony, a one arm bandit as a mascot....woof, woof....go ahead dogs, attack....