Robinhood suicide story -- unclear on Margin issues

[Fred_11]

Something I still don't understand re: the Robinhood suicide story (threads elsewhere on ET: 1, 2) that perhaps an options-specific forum might be able to explain.

The narrative at this point is that the kid misinterpreted the negative $730K cash balance he saw as a debt he owed, when in actuality it was just due to one leg of a spread having settled. Much has been written about how RH should have had clearer messaging to avoid user confusion etc, but I still haven't seen an explanation for the bigger Q: how was it that a $16K account -- what this kid apparently had -- could ever have even opened the kinds of positions that would result in a -$730K cash balance being displayed (even if it was illusory)?

This Forbes article offered an illustration of how the situation could have come about, using an example of an AMZN Bull Put spread:

Here’s an example of how a bull put spread could produce an unexpectedly large stock position in your portfolio. On June 16, Amazon (AMZN) trades at $2,615 per share. If you’re neutral to bullish on Amazon, you could sell put options that expire on July 17 with a $2,615 strike price for $28 per option. To limit your risk, the other leg of the trade is to purchase puts at a lower strike price, $2,610, for a cost of $26. That two-dollar differential (multiplied by 100) generates $200 for every contract you sell. Do three contracts and you generate $600. If Amazon closes on July 17 above $2,615, you’re in the clear and keep all of the proceeds, as both puts expire worthless. If the stock closes below $2610, you will encounter your maximum loss of $900: $5.00 (difference between strike prices) minus $2.00 (proceeds earned up front) times three contracts.

When the stock closes between the two strike prices, the put you bought at the lower strike price expires worthless, but the one you sold is in the money and legally binds you to buy the stock at the strike price. In the case of three contracts of $2,615 Amazon puts, that would be $784,500 to purchase 300 shares. Over a weekend, say, you may see a –$784,500 debit to buy the stock, but you would not see the stock among your holdings until Monday.

I don't trade credit spreads, but what I don't understand is this: how would a $16K account even be able to put on that kind of trade in the first place given margin restrictions? Isn't Forbes using an example that would be functionally impossible for an account of that size? (Yes, I know about infinite-leverage bug so margin issues not RH's strong-suit, but still.)

In short, I understand how an illusory negative cash balance result from only 1 leg of a spread exercising/settling, but I just don't understand how any series of option transactions or settlements in an account with a ~$16K value could ever result in that magnitude of a deficit.

Can someone who has more experience with such spreads help clarify? Is it plausible that a $16K account would have been able to put on a trade like the one described in the Forbes piece? And if yes, wouldn't a brokerage have liquidated positions long before any scenario in which a $16K account would be looking at buying $730K(!) worth of stock?

 

[guru]

This has happened to me too, at Interactive Brokers, and probably to many option traders at various brokers. Like you mentioned, this was a display bug, illusory, therefore not true. There was never such risk, and anyone even with small account can have no risk but see some strange numbers due to a bug. A bug doesn’t mean that such risk existed, while it’s ok to trade with small account and having no sizable risk.
The bug, which again, is common at many brokers, is that after being assigned short shares overnight, it shows the balance of your cash without relation to your remaining options positions that may insure you against losses. His other leg/option acted as a hedge/insurance, therefore negating and invalidating the risk. So there was never a large risk. Cash was negative, option made it positive, so his overall balance could still be $16k or a little less or a little more. There was never $700k risk, so he was allowed to trade without risk.

 

[zdreg]

The bottom line is did some low level chat person at RH tell the client he was responsible for a 700k loss.Does that make the firm responsible for his suicide. The other thing this kid did not understand how spreads work.

Just for the record there is one clueless poster who claims that the people who inherit his estate would be personally liable for any losses in the account.

 

[Fred_11]

The bottom line is did some low level chat person at RH tell the client he was responsible for a 700k loss.Does that make the firm responsible for his suicide.

Yeah, my hope is not to go too far down the rabbit hole as to whether RH bears any culpability for his death -- the two threads linked to in the OP have plenty of that chatter -- but rather focus on the quantitative margin issues, and whether positions of the type/magnitude Forbes hypothesized in their hypo were actually possible in a mere $16K account.

This has happened to me too, at Interactive Brokers, and probably to many option traders at various brokers. Like you mentioned, this was a display bug, illusory, therefore not true. There was never such risk, and anyone even with small account can have no risk but see some strange numbers due to a bug. A bug doesn’t mean that such risk existed, while it’s ok to trade with small account and having no sizable risk.
The bug, which again, is common at many brokers, is that after being assigned short shares overnight, it shows the balance of your cash without relation to your remaining options positions that may insure you against losses. His other leg/option acted as a hedge/insurance, therefore negating and invalidating the risk. So there was never a large risk. Cash was negative, option made it positive, so his overall balance could still be $16k or a little less or a little more. There was never $700k risk, so he was allowed to trade without risk.

Yes, I understand the mechanics and have experienced the same myself. (I'm not even sure I'd call it a "bug" as much as poor UX / messaging...) But I'm still dubious as to how a deficit (even an illusory one) of that size/magintude could occur in a $16K account. No, obviously there was never a $700K "risk", but to say there was "never a large risk" isn't true. E.g. per the Forbes hypo, AMZN could have gapped down overnight, and his 300 long shares would have been nowhere near enough to cover the negative cash balance. Based on my experience, I don't think a $16K account would have been able to put on a spread the size of the AMZN example, but you think otherwise? I still feel like we're not getting the entire story.

 

[guru]

AMZN could have gapped down overnight, and his 300 long shares would have been nowhere near enough to cover the negative cash balance

Looks like you've missed the point that those shares were fully hedged by the other/remaining option leg. So whether AMZN share price went to $0 or $1 million, it wouldn't matter. A hedge is a hedge and nothing can happen wherever AMZN price lands.
Basically if AMZN drops to $0 then his remaining put would make tons of money - enough to cover any difference. So it was never possible for him to lose more than maybe $5K, or whatever his option spread's max loss was.
A loss would've been possible only if somehow he was able to sell his remaining leg (his hedge) and then he'd be fully exposed to huge losses. But Robinhood (and all brokers) don't allow this without sufficient capital/margin, and that's exactly how Robinhood managed risk for this person. There was no risk

 

[old coot]

This is an example, I don't know the position the young man was in, but I do know how options work.
Look right now, at yahoo finance, put in AMZN and click on options. scroll down to puts. OK, using the yahoo numbers for last price, at the very end of the day, suppose you were to think amzn was going up, you could buy 2680 puts for $41.50, or $4,150 per contract. Furthermore, since you believe AMZN is going up Monday, you can sell 2700 puts for $50, or $5000 per contract. So, you get 5k, and you spend $4,150, for a net profit of $850. All you need is the cash to cover the difference in your options, in the even it does go lower than 2680, you'll have to cover the difference between strikes , which is $20, or $2000 per contract. You're in the trade, you know exactly how much you can lose(max $2000, but you got $850 from selling ) and exactly how much you can win(max $850) If AMZN goes(and stays until expiration) below 2680, your put covers everything from there down. If AMZN goes above 2700, the other put, that you sold, expires worthless, as does yours, and you have the $850 from the trade. Additionally, if you're selling, time decay of premium works in your favor.

In theory, the AMZN put represents 100 shares of AMZN, which, at the end of the day posted at 2,692.87, or, for the contract, 269,287.00,

The reality is that you are not selling the shares, you're trading in contracts of options. I've seen the cash value of a contract of oil futures, and ES, both are alarming if you think you need to pony up that much. However, you don't. The total amount of money is covered above. That's why companies let people do that. If the young man's short options were exercised(unlikely since that rarely happens) the company would have had to exercise his long options, at the same time. It just is. This is not nearly as complicated as y'all letting on. It's sad that the young man killed himself, but it was nothing that anybody did, except himself. You have to educate yourself. He didn't owe anybody any money. and, if he was trading options, it was up to him to understand what he was doing.

Futures traders trade the S&P mini contract, in theory, they're worth $50 times whatever the S&P quote is, which at the end of the day Friday, was 3,009.05 so the contract would be worth $50 time that, or $150,452.50. You don't put up 150 thousand dollars, you are trading 1 contract of ES. Nobody would even begin to believe that.

Clearly there needs to be a more thorough test or something, but these things are fairly straightforward. It's an option contract, not the actual stock. In futures traders case, a futures contract, not buying the S&P. No broker is going to let you trade options or futures unless you state that you have an understanding of them. They are not at fault. The fellow killed himself, and sad as that may be, it was no one's fault but his own. No rational person would kill himself if they really did owe that much money, and if he had enough understanding to be selling bull put spreads, he should have understood exactly what he was doing, and what he would be responsible for, in the above made up example, at most the $2000 for the difference in strikes. and, of course, he got $850 to offset that, including that his loss would be $1150. At $2688.50, he'd be even(minus commissions, so at $2690, he'd be down $1.50 times 200 shares, or $150. And so on.

I may have missed some numbers or something, since I'm pretty well medicated right now, but that is how it works.

 

[guru]

Yeah, my hope is not to go too far down the rabbit hole as to whether RH bears any culpability for his death -- the two threads linked to in the OP have plenty of that chatter -- but rather focus on the quantitative margin issues, and whether positions of the type/magnitude Forbes hypothesized in their hypo were actually possible in a mere $16K account.



Yes, I understand the mechanics and have experienced the same myself. (I'm not even sure I'd call it a "bug" as much as poor UX / messaging...) But I'm still dubious as to how a deficit (even an illusory one) of that size/magintude could occur in a $16K account. No, obviously there was never a $700K "risk", but to say there was "never a large risk" isn't true. E.g. per the Forbes hypo, AMZN could have gapped down overnight, and his 300 long shares would have been nowhere near enough to cover the negative cash balance. Based on my experience, I don't think a $16K account would have been able to put on a spread the size of the AMZN example, but you think otherwise? I still feel like we're not getting the entire story.

Ah, and I just noticed your Forbes article/example stating "When the stock closes between the two strike prices, the put you bought at the lower strike price expires worthless, but the one you sold is in the money and legally binds you to buy the stock at the strike price"

But I don't think that that's what happened because Robinhood doesn't allow/support such scenarios. Robinhood will exit/sell your position one hour before expiration to assure that you don't end up with unhedged shares. This is what happens to my wife who trades on Robinhood. Robinhood policy on this is also stated: "If one leg is at risk of being in the money or in the money, we'll close the spread or match the option with another form of collateral (like cash or stocks) and let you exercise it."
There may be some rare scenarios where you could end up with just shares, but that could be outside of Robinhood's control and therefore wouldn't mean that Robinhood allows people to take on such risk. And even then, the trader would simply try to get out of his position the next morning, understanding that he has 300 shares that may or may not change in price.

 

[taowave]

Hypothetically,he could sell 3 AMZN 5 point wide put spreads at 4..Max risk 300 dollars..

Getting assigned on the short put doesn't change the risk,but will turn the position into a synthetic call.. Long Stock/Long Put..

Im not sure of the cap hit,but he could have simply exercised his long put and taken the hit,or kept the synthetic on.But as I said,I am not sure what the cap is for long stock,long ITM put..

Something I still don't understand re: the Robinhood suicide story (threads elsewhere on ET: 1, 2) that perhaps an options-specific forum might be able to explain.

The narrative at this point is that the kid misinterpreted the negative $730K cash balance he saw as a debt he owed, when in actuality it was just due to one leg of a spread having settled. Much has been written about how RH should have had clearer messaging to avoid user confusion etc, but I still haven't seen an explanation for the bigger Q: how was it that a $16K account -- what this kid apparently had -- could ever have even opened the kinds of positions that would result in a -$730K cash balance being displayed (even if it was illusory)?

This Forbes article offered an illustration of how the situation could have come about, using an example of an AMZN Bull Put spread:



I don't trade credit spreads, but what I don't understand is this: how would a $16K account even be able to put on that kind of trade in the first place given margin restrictions? Isn't Forbes using an example that would be functionally impossible for an account of that size? (Yes, I know about infinite-leverage bug so margin issues not RH's strong-suit, but still.)

In short, I understand how an illusory negative cash balance result from only 1 leg of a spread exercising/settling, but I just don't understand how any series of option transactions or settlements in an account with a ~$16K value could ever result in that magnitude of a deficit.

Can someone who has more experience with such spreads help clarify? Is it plausible that a $16K account would have been able to put on a trade like the one described in the Forbes piece? And if yes, wouldn't a brokerage have liquidated positions long before any scenario in which a $16K account would be looking at buying $730K(!) worth of stock?

 

[Axon]

Idon't trade credit spreads, but what I don't understand is this: how would a $16K account even be able to put on that kind of trade in the first place given margin restrictions?

It's profoundly straightforward with the most rudimentary understanding of how spreads work. You sell one thing and buy another. On the chance the short option expires in the money and the long expires worthless, you get assigned the shares then they are immediately sold. The risk is the offset, i.e., difference after all involved trades are settled. You do not calculate the risk as a function of either singular leg as that is nonsensical. This situation has been bikeshedded to death over such a trivial misunderstanding that would take 5 minutes on investopedia to clear up.

Trivial example: You sell a put with a notional value of 730k and the price drops below your strike. You get assigned OMG. But all is not lost! The shares you just bought are still worth something like 727k so you immediately sell them. Your total loss was 3k minus the premium. But what if the total shares' value dropped to 200k. Well you still have that put you bought as the other leg in your spread. You sell your shares to whoever bought that put thus the worst case scenario is you lost something like 5k. That was your max risk in the beginning no matter how low the share price goes. Not 730k. 5k (in this example).

 

[Fred_11]

Ah, and I just noticed your Forbes article/example stating "When the stock closes between the two strike prices, the put you bought at the lower strike price expires worthless, but the one you sold is in the money and legally binds you to buy the stock at the strike price"

But I don't think that that's what happened because Robinhood doesn't allow/support such scenarios. Robinhood will exit/sell your position one hour before expiration to assure that you don't end up with unhedged shares. This is what happens to my wife who trades on Robinhood. Robinhood policy on this is also stated: "If one leg is at risk of being in the money or in the money, we'll close the spread or match the option with another form of collateral (like cash or stocks) and let you exercise it."
There may be some rare scenarios where you could end up with just shares, but that could be outside of Robinhood's control and therefore wouldn't mean that Robinhood allows people to take on such risk. And even then, the trader would simply try to get out of his position the next morning, understanding that he has 300 shares that may or may not change in price.

Exactly. Your previous reply suggested that I was perhaps missing the rather elementary premise that your long Put hedges your short Put, so -- a the time you put on the trade -- your risk is limited to the difference between the two Strikes (x # of contracts). Yes, that's credit spread 101. What I think is fishy is Forbes' illustrative hypothetical -- I don't think that would ever happen at a broker with proper margin / risk-management controls. Think about it: the Forbes author is suggesting that on Monday morning (using the #'s in their hypo), the trader would have woken up to a negative cash balance of $784.5K, but long that amount of AMZN stock. Which is all good and well, except in the case AMZN gaps down 10% over the weekend, which is insane exposure in a $16K value account, so I think we're saying the same thing: that a brokerage would have liquidated positions long before there was the risk of that kind of exposure (if they even allowed them to be put on in the first place.) So what I suppose this comes down to is that I don't think the Forbes hypo is a plausible explanation of for happened, unless RH had wildly irresponsible internal risk controls.