Robinhood suicide story -- unclear on Margin issues

Fred_11 said:
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.
More...


Agree. Forbes might've been trying too hard to analyze the scenario(s), while possibly also not being aware of how Robinhood deals with option spreads near expiration, and generally their risk controls.
 
Fred_11 said:
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?
More...

Cuz they don't check for the margin according to the potential buying power of the account AFTER a potential assignment from shorting the options. They only check the margin according to the option transactions. Since option prices are usually small comparing to the underlying's price so whatever was in the account would be sufficient to cover it.

Example:

Underlying's price is $36.00. So if he sells 200 put contracts then his/her potential assignment liability would be $36 X 200 X 100 = 720,000 should the put contracts all become ITM

But when he was selling the contract, the price of each put is only let's say $0.5. So for 200 put contracts, it's only 0.5 X 200 X 100 = $10,000 well within the amount that's in his account of $16,000. Especially that he did a vertical spread which means he also bought the same amount of put contracts for hedging, so his margin requirement would be even lower. So he definitely be cleared by RH.

The only problem happens when the short leg becomes ITM and the long leg doesn't depending on the spread of his vertical, then he would be on the hook for the entire $720,000 to buy the shares but without any assignment from the long leg to cover it.

But judging from the story, the guy's spread might not be that large that he was getting a one-sided assignment on the short and not the long because he thought the two were supposed to cancel each other out but you never know. Clearly the guy was trading something that he obviously had very little understanding about. And when he couldn't understand something he didn't want to ask. WHY didn't he just ASK somebody???? If only he ASKED somebody... :(
 
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.
 
Last edited:
In addition,there are scenarios that his position at the time he received notice of a 720k deficit his account was actually profitable.
It is possible that RH closed his position and the account showed a resultant profit.
 
Last edited:
Pekelo said:
Bingo. Infinite margin and such...
More...

Right -- as I wrote in the OP, RH's past goofs in this regard are well-documented and it wouldn't surprise me to learn that they screwed up some other margin / risk-control setting. But so far, there's no evidence that that's what happened in this case. The only explanation offered centers on poor messaging in their software combined with a trader who was in way over his head and didn't know what he was doing. But I created this thread mainly to try and understand if, beyond those elements, there was an actual legal or regulatory screw-up on RH's part.
 
JSOP said:
Example: Underlying's price is $36.00. So if he sells 200 put contracts then his/her potential assignment liability would be $36 X 200 X 100 = 720,000 should the put contracts all become ITM

But when he was selling the contract, the price of each put is only let's say $0.5. So for 200 put contracts, it's only 0.5 X 200 X 100 = $10,000 well within the amount that's in his account of $16,000.
More...

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.
 
Fred_11 said:
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.
More...
The sold puts are not naked. They are offset by the puts with strike price of 25.
 
You must log in or register to reply here.
Back
Top