Expiration & Corporate Action Related Liquidations

Background:

In addition to the policy of force liquidating client positions in the event of a real-time margin deficiency, we will also liquidate positions based upon certain expiration or corporate action related events which, after giving effect to, would create undue risk and/or operational concerns. Examples of such events are outlined below.

Option Exercise

We reserve the right to prohibit the exercise of stock options and/or close short options if the effect of the exercise/assignment would be to place the account in margin deficit. While the purchase of an option generally requires no margin since the position is paid in full, once exercised the account holder is obligated to either pay for the ensuing long stock position in full (in the case of a call exercised in a cash account or stock subject to 100% margin) or finance the long/short stock position (in the case of a call/put exercised in a margin account). Accounts which do not have sufficient equity on hand prior to exercise introduce undue risk should an adverse price change in the underlying occur upon delivery. This uncollateralized risk can be especially pronounced and may far exceed any in-the-money value the long option may have held, particularly at expiration when clearinghouses automatically exercise options at in-the-money levels as low as $0.01 per share.

Take, for example, an account whose equity on Day 1 consists solely of 20 long $50 strike call options in hypothetical stock XYZ which have closed at expiration at $1 per contract with the underlying at $51. Assume under Scenario 1 that the options are all auto-exercised and XYZ opens at $51 on Day 2. Assume under Scenario 2 that the options are all auto-exercised and XYZ opens at $48 on Day 2.

Account Balance Pre-Expiration Scenario 1 - XYZ Opens @ $51 Scenario 2 - XYZ Opens @ $48
Cash $0.00 ($100,000.00) ($100,000.00)
Long Stock $0.00 $102,000.00 $96,000.00
Long Option* $2,000.00 $0.00 $0.00
Net Liquidating Equity/(Deficit) $2,000.00 $2,000.00 ($4,000.00)
Margin Requirement $0.00 $25,500.00 $25,500.00
Margin Excess/(Deficiency) $0.00 ($23,500.00) ($29,500.00)

*Long option has no value loan.

To protect against these scenarios as expiration nears, we will simulate the effect of expiration assuming plausible underlying price scenarios and evaluating the exposure of each account assuming stock delivery. If the exposure is deemed excessive, we reserve the right to either: 1) liquidate options prior to expiration; 2) allow the options to lapse; and/or 3) allow delivery and liquidate the underlying at any time. In addition, the account may be restricted from opening new positions to prevent an increase in exposure. We determine the number of contracts that will be lapsed by us/auto-exercised shortly after the end of trading on the date of expiration. The effect of any after hours trading you conduct on that day may not be taken into account in this exposure calculation.

While we reserve the right to take these actions, account holders are solely responsible for managing the exercise/assignment risks associated with the positions in their accounts. We are under no obligation to manage such risks for you.

We also reserves the right to liquidate positions on the afternoon before settlement if our systems project that the effect of settlement would result in a margin deficit. To protect against these scenarios as expiration nears, we will simulate the effect of expiration assuming plausible underlying price scenarios and evaluating the exposure of each account after settlement. For instance, if we project that positions will be removed from the account as a result of settlement (e.g., if options will expire out of the money or cash-settled options will expire in the money), our system will evaluate the margin effect of those settlement events.

If we determine the exposure is excessive, we may liquidate positions in the account to resolve the projected margin deficiency. Account holders may monitor this expiration related margin exposure via the Account window located within the TWS. The projected margin excess will be displayed on the line titled “Post-Expiry Margin” (see below) which, if negative and highlighted in red indicates that your account may be subject to forced position liquidations. This exposure calculation is performed 3 days prior to the next expiration and is updated approximately every 15 minutes. Note that certain account types which employ a hierarchy structure (e.g., Separate Trading Limit account) will have this information presented only at the master account level where the computation is aggregated.

Note that we generally initiate expiration related liquidations 2 hours prior to the close, but reserves the right to begin this process sooner or later should conditions warrant. In addition, liquidations are prioritized based upon a number of account-specific criteria including the Net Liquidating Value, projected post-expiration deficit, and the relationship between the option strike price and underlying.

Call Spreads in Advance of Ex-Dividend Date

In the event that you are holding a call spread (long and short calls having the same underlying) prior to an ex-dividend date in the underlying, and if you have not liquidated the spread or exercised the long call(s), we reserve the right to: i) exercise some or all of the long call(s); and/or ii) liquidate (i.e., close out) some or all of the spreads - if we, in its sole discretion, anticipates that: a) the short call(s) is (are) likely to be assigned; and b) your account would not ave sufficient equity to satisfy the liability to pay the dividend or to satisfy margin requirements generally. In the event that we exercise the long call(s) in this scenario and you are not assigned on the short call(s), you could suffer losses. Likewise, if we liquidate some or all of your spread position, you may suffer losses or incur an investment result that was not your objective.

In order to avoid this scenario, you should carefully review your option positions and your account equity prior to any ex-dividend date of the underlying and you should manage your risk and your account accordingly.

Physically Delivered Futures

With the exception of certain futures contracts having currencies or metals as their underlying, we generally do not allow clients to make or receive delivery of the underlying for physically settled futures or futures option contracts. To avoid deliveries in an expiring contract, clients must either roll the contract forward or close the position prior to the Close-Out Deadline specific to that contract (a list of which is provided on the website).

Note that it is the client’s responsibility to be aware of the Close-Out Deadline and physically delivered contracts which are not closed out within the specified time frame may be liquidated by us without prior notification.