Robinhood suicide story -- unclear on Margin issues

[zdreg]

There's absolutely no way a $16K account would be able to sell 200 such naked Puts on a $36 underlying.

Correct. You should explain why.

In the above example the difference between strike price of 36 and 25 is 11 points. maximum loss is $1100 per option. divide 16000 by 1100 =15 contracts. 15 options is his maximum position.

PS there are certain people who will post erroneous information who are simply clueless. You can gently correct them but with their bruised ego will continue to post misinformation.

 

[JSOP]

I think you're confusing premiums received with margin required to put on the short position. Yes, if you sell 200 Puts for $0.50 each, you'll take in $10,000 in premiums. But that has nothing to do with the margin required for that kind of a position. There's absolutely no way a $16K account would be able to sell 200 such naked Puts on a $36 underlying.

The margin requirement for option sellings is calculated based on option premiums. https://www.great-option-trading-strategies.com/selling-puts-on-margin.html#:~:text=The Initial and Margin Maintenance Requirement for broad-based index,of the option premium value

Here is a site that outlines in general how margin requirements are calculated. Each broker of course has its own policy but this is usually how margin requirements for option selling for all brokers. You can see for puts, true, part of the margin requirement is also based on the strike price of the option written for option selling but if he happened to have written an initially deep out-of-money put but then the underlying happened to have moved fast south unaccounted for by the premiums then he could still have satisfied the margin requirement but then be on the hook for large losses.

Again, this is why you 1) do not trade something that you do not fully understand and 2) when you REALLY don't understand something, you ASK, you COMMUNICATE.

 

[zdreg]

The margin requirement for option sellings is calculated based on option premiums. https://www.great-option-trading-strategies.com/selling-puts-on-margin.html#:~:text=The Initial and Margin Maintenance Requirement for broad-based index,of the option premium value

Here is a site that outlines in general how margin requirements are calculated. Each broker of course has its own policy but this is usually how margin requirements for option selling for all brokers. You can see for puts, true, part of the margin requirement is also based on the strike price of the option written for option selling but if he happened to have written an initially deep out-of-money put but then the underlying happened to have moved fast south unaccounted for by the premiums then he could still have satisfied the margin requirement but then be on the hook for large losses.

Again, this is why you 1) do not trade something that you do not fully understand and 2) when you REALLY don't understand something, you ASK, you COMMUNICATE.

It is a nice technique to publish something that diverts attention away from your previous error filled post. I doubt it will fool anyone.
unfortunately this link barely touches on the subject of spreads and is not connected to the subject of this thread.

 

[ironchef]

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?

For his account, in the Forbes example, the other side of the ledger should show he owned 300 shares of AMZN. And he should have three days to settle.

 

[Fred_11]

The sold puts are not naked. They are offset by the puts with strike price of 25.

(In the part of the poster's reply, he hadn't yet mentioned it being a spread with a Long 25 Put position, which is why I wrote that, but as you've already identified, there were other problems with that reply...)

Posters are complicating a simple situation. This was the deceased position without knowing the actual number of contracts.

Position: spread bought 25 strike put sold 30strike put maximum loss $500 for 1 option spread.
Current price 27.
30 strike put is exercised against you. You are now long 100 shares at $30

Why would you exercise the 25 put as some posters suggested and take a $500 loss when you can sell the stock at $27 and limit your loss to $300? (The actual loss is smaller if you include the cash/premium received from selling the 30 put.)

the maximum number of contracts in his account is the cash he deposited in account divided by $500-(maximum loss) e.g. if you deposited 20k the maximum number of contracts allowed is 40. The 20k deposit completely protects RH in all scenarios.

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..

^^ I agree with both of these replies, of course, except in the case -- and this was one of the elements of the Forbes example -- where nearing the Expiry date, his Long is set to expire OTM, but his Short is ITM and will be assigned. (At IB, for example, they not only track your real-time margin, but also displays a line for your post-expiry predicted margin, and if that number is negative (which it has often been for me as the minutes tick down to Friday 4pm), I'm pretty sure they'll liquidate positions even if you're not yet in a margin deficit.)

So yes, while at the time he put the spread trade on, his loss was limited to the difference between the Strikes x the # of contracts, his risk could be substantially more as Expiry drew near, time-values went to zero and the value of his Long leg also dropped (presuming the underlying was set to close in between the leg Strikes). So Forbes is theorizing that a client account with a $16K value could theoretically, on account of option settlements, have had a -$785K cash "balance" and ~$785K in AMZN stock. Obviously a $16K account wouldn't ever be able to purchase $785K in AMZN stock, so I'd have assumed that a broker's risk control would prevent that scenario from coming about via option transactions, no?

 

[zdreg]

I'd have assumed that a broker's risk control would prevent that scenario from coming about via option transactions, no?

It is certainly true at IB. . Whether it is true at RH who knows? I would not assume anything
about Wall Street in general and in particular their ability to properly track customer trades for margin purposes. Surprisingly that includes trading that consists entirely of stocks and no option positions.

 

[Fred_11]

Let me put a finer point on it and use hard numbers, because I think the crux of what I'm trying to get to the bottom of is this: are brokerages required by law to monitor (and have risk controls to prevent) real-time assignment liability, even when a spread -- at the time it's opened -- would be fully hedged?

Example:

You have a $16K cash balance on June 20th and AMZN's trading at $2,615. Being neutral-to-bullish, you put on this spread:

i) Buy 3 x July 17th $2,610 Puts for $26.00 each (tot cost: $7,800)
ii) Sell 3 x July 17th $2,615 Puts for $28.00 (tot premiums received: $8,400)

Your account balances are now:

a) Long 3 x 2,610 Puts
b) Short 3 x $2,615 Puts
c) $16,600 cash​

No disagreement (i hope) that at the time you put on this trade:

i) You're +$600 from the difference in the premiums paid/received;
ii) Your max loss is -$900 (if both legs expire ITM > -$1,500 + $600 premiums)
​

So as some ITT have pointed out, there's little risk here in letting a $16,000-value account put on this spread when his max loss is $900.

However there's absolutely much higher risk that can accrue as Expiry approaches. If at 3:55pm on July 17th AMZN's underlying is trading at $2,613, and it looks like his Long $2,610 will expire OTM but he'll be Assigned on the $2,615 short, a client (and his brokerage) would be looking at significant liability over the weekend. E.g. if there's bad news for AMZN and it opens Monday at $2,400, the client's account balances would be:

i) Long 300 AMZN (value: 300 x $2,400 = $720K)
ii) (-$767.9K) negative cash balance ($16.6K from above -$784.5K from Assignment on $2,615 Put)

>> Even if a brokerage liquidates the 300 x AMZN near the open, the client is in ~$48K in the hole (3x the size of a $16K account!)​

My questions are:

Do brokers have risk controls that would prevent a $16K account from putting on the above spread all the way back on June 20th, on the theory that even though there's little risk at the time, there will be risk (or at least there could be) that accrues closer to expiry? And if they do have such controls, is that required by law or just by individual brokerage policy?

(I think the way IB handles this is that they calculate the expected post-expiry margin snapshot as Expiry approaches, and if you'd be in a margin deficit (assuming all ITM exercises), they liquidate positions prior to Expiry; e.g. in the example above, they'd liquidate the short 3 x $2,615 Put / aka force client to close it with the account's $16,600 cash balance -- before the value of the short exceeds that, of course -- as Expiry approaches.)

​

 

[zdreg]

Do brokers have risk controls that would prevent a $16K account from putting on the above spread all the way back on June 20th, on the theory that even though there's little risk at the time, there will be risk (or at least there could be) that accrues closer to expiry? And if they do have such controls, is that required by law or just by individual brokerage policy?

There is ZERO risk for the brokerage firm prior to the last day. It is offset by the lower price puts that you own. There is no special policy required except for the last day exercise.

 

[zdreg]

On the last day if you don't buy back the higher price put options by 3:45 pm they will automatically close it by buying the options.


( The exception MAY be if you have enough cash in the account to margin the stock if it were to open at.01 Monday. You have to be very foolish to allow yourself to be in that position.) This is one more reason to read the option prospectus very carefully and to know the policy of your brokerage firm.

 

[cr1stal]

most likely it was an error by their pricing. very clear margin agreements were in place. having closed it at -500k they will then have refused to negotiate except via debt collectors, insolvency proceedings correctly judging that he would kill himself. he did not forget the children of darkness and he did avenge their persecutors and they did say 'my-my-my he is a bad man but his name is the lord as he laid his vengence upon them'