Quote from IBj:
I read through the thread trying to gather all the comments, misunderstandings, genuine informational gaps, etc. As is often the case on long threads, there are a lot of posts based on poor/incomplete information and assumptions. Here is an attempt to clarify matters:
(1) What caused the liquidations
The liquidations were NOT caused by the valuation on the options, nor on option margin. As some posters have pointed out, there is no equity value for options in a regT account, and the margin for a long vertical options spread is zero.
The OP/client had other positions in the account that caused the initial margin deficit. The liquidations were triggered by the client carrying a leveraged position many times the value of the account (measured in net liq) in a non-base currency. The long non-base currency fell 1.8% during the trading session creating a situation where his cash value (measured in his base currency) was less than the margin requirement for the currency position, thereby triggering a liquidation need. By the time the liquidations were done, the currency had moved 3.6%, a giant move.
By example:
* position at beginning of trading session: -100K USD, +103K XXX @ 1.00. This account has a margin requirement of 2500 USD, and is covered by the excess 3K measured in the base currency USD.
* position at time of liquidations: -100K USD, +103K XXX @ 0.98 (XXX/USD). Now the value of XXX is only 100.9K expressed in USD, so total cash value is only 0.9K USD. Margin requirement is still 2.5% of the debit 100K USD, i.e. 2500. Margin requirement exceeds capital, so liquidation requirement is triggered.
(2) Quality of liquidations
The liquidations executed before the market began its serious melt at ~14:25 were fine. The ones executed during the freefall that began 2 minutes later and lasted ~45 minutes were not so good.
To understand the execution quality, you have to look at the market data and it is pretty evident that the market was in chaos with option spreads 30X wider than normal (ex: 3.85 bid / 9.00 ask). Under these circumstances -- during arguably the most violent market moves in history -- execution quality for all orders was problematic, both for customer initiated and IB initiated orders. all asset classes were affected: stocks, options, futures, currencies, bonds.
IB will address the execution points privately with the client (off this thread) as part of a normal complaint resolution.
(3) Method of execution
IB has a preferred liquidation sequence depending on the reason for the liquidation. For margin deficiencies, we typically look to futures/FOPs first, then other commodity segment derivatives, stocks and equity segment derivatives, then currencies. For money driven liquidations (certain accounts/segments are not permitted to have negative cash), the sequence is to sell instruments that generate cash. There are other algorithms and prioritization logic as well. We don't so far have algorithms that liquidate "strategies" using combos because many exchanges do not accept combination orders.
In total, the question of which position to liquidate can be non-trivial as there may be conflicting priorities: do the thing that creates most margin benefit, or the one that has the tightest bid-ask spread (implying the smallest pnl-to-mid), or one that reduces risk the most (not the same as reducing margin the most), or the one that reduces leverage the most. There is no "right answer" for all situations. In this case, in hindsight, I can come up with a better liquidation process.
Summary:
1) Maintain substantial excess financial capacity. The poster who always leaves 30% excess: yes. In volatile market conditions, even more because we saw moves on Thursday that are 1 in 2M types of events, and even 30% gets quickly eaten up in such situations. Having excess financial capacity is the best way to avoid liquidations. Unfortunately, the client/OP did not have substantial excess given the degree of leverage in the currency positions.
2) Last Thursday exposed several places where IB can improve its risk management systems. Liquidation processes will also be improved. I expect the first of these changes to start rolling out within a month.
3) IB's risk management system is expressly designed to automatically liquidate deficient accounts. While automation is key to our whole business model, we also have people 24x6 continuously looking at the risk systems and pending liquidations; they find situations where we feel it appropriate to interrupt the automated process. But when the markets are free-falling, IB personnel cannot manually supervise the close out transactions in individual portfolios because there simply is no time to evaluate and execute alternative liquidation methods.
IB does not want to liquidate anyone's account. It is bad for the client, bad for IB (hence this thread). We do it because regulations stipulate how much leverage can be granted, and not doing so can often be far worse financially for both the client, IB, and ultimately, other customers (because they indirectly inherit the credit risk of failed accounts). To repeat myself, having sufficient capital for the degree of leverage in your account is the best way to avoid liquidation/close out risk.
