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Interactive Brokers & Re-hypothecation

Posted: Sat Dec 10, 2011 5:52 am
by rhc
From page 35 of the the “MF Globalâ€

Posted: Sat Dec 10, 2011 7:06 am
by Moto moto
Thanks RHC.....

try and say this in one sentence without taking a few breaths....
From the IB fully disclosed Clearing Agreement.

4. To the extent allowed by the Laws and Regulations, Interactive and its affiliated companies
("Affiliates") may engage in stock lending activity and the lending of Customer collateral, securities or other property including, but not limited to, using Customer collateral, securities or other property for their own accounts or for the accounts of other Customers, and lending, either to themselves, to their Affiliates, or to others, any Customer collateral, securities and other property held by Interactive in Customers' Fully-Disclosed Accounts.
Pursuant to applicable Laws and Regulations, Interactive or its Affiliates may deposit
collateral, securities and/or other Customer property with third parties and may pledge, re-pledge, hypothecate or re-hypothecate Customer collateral, securities and/or other
Customer property, either separately or together with other securities and/or other property of other Customers of Interactive for any amount due to Interactive in any
Interactive Fully-Disclosed Account in which Customer has an interest. Interactive or its
Affiliates, may so pledge, re-pledge, hypothecate or re-hypothecate Customer collateral, securities and/or other property without retaining in Interactive's or its Affiliate's possession or under its control for delivery a like amount of similar collateral, securities and/or other property and Interactive or its Affiliates may return to Customer collateral, securities and/or other property other than the original, or original type of, collateral, securities and/or property that Customer deposited with Interactive. Collateral that is registered with a third party may not be in Customer's name.

One thing to note here.....stock borrowing is very different to just re-hypothecation of lending on lending, and the futures market. Maybe this is the red herring. It has been happening for a long time. It is normal. (it happens in other industries as well - think insurance and re-insurance)

Personally I have three separate accounts with IB, and have already withdrawn any excess money from them but keeping the accounts open and funded as it has been mentioned before...regardless of what they say, there is no reason to keep excess money with them. (not that anywhere might be as safe :))

The other thing that this does highlight is ....few people read these documents, and even if you do they are hard to follow and understand, and that there is not much else you can do if you wish to open an account and use leverage. You have always been comingled with other accounts at these firms....thats why there are clearing houses.
Extra transparency wont help if people dont understand the buisness, or choose not to worry about it when it is explained to them.
These firms have been surviving on utilising other peoples money and taking a clip, this is why brokerage has been coming down in recent years.....I dont see this as too much of an issue. It is more when it is sent out to entities not under the same umbrella and risk controls. The problem is that everyone is facing the same problems.....where, how much and how safe is the money.
(dont single out Interactive Brokers....they are generally all the same and have the same issues)

Posted: Sat Dec 10, 2011 7:27 am
by rhc
Wow!, reading that item 4 in the IB clearing Agreement has given me a sore head. *rubs right temple*

Further on this item 4 & on Hypothecation and Re-Hypothecation in general, from; ... 21011.html
If you open an account with a commodities broker or even with a stock broker on margin, you sign a document acknowledging the company has the right to use the securities and the cash in your account as collateral against the financing they get from banks to loan to you. In other words, they borrow money from banks at say, 3% to loan to you at say, 6% and pledge your assets against those loans. It's called hypothecation and is perfectly legal.

They can also make investments in their name using your assets. But the investments have to be in something safe, such as Greek government bonds now paying 352% (!!??) That's called re-hypothecation and again, you signed a document when you opened your margin account saying they could do that. It's perfectly legal.

Jon Corzine may go to jail for lying to Congress but he isn't going to jail for stealing your money. What he did was legal
(Note: Underlined Bold emphasis mine)

Posted: Sat Dec 10, 2011 7:55 am
by Moto moto
yes...most of it is probably you sign agreements. Thats why a lot of this may end up getting bogged down in something else. Often the transfer may be legal, the miss selling, or the failure to do something else, or something like mail fraud, or tax evasion will actually be charged.

Re Interactive Brokers..that ET thread
It has some items of interest. An interesting read. for those inclined to skip quickly through it
page 27 , 28 a quick place to start

As in trading, all you can do is minimise risk, diversify and panic before others.

Posted: Sat Dec 10, 2011 11:25 am
by trackstar
Thanks for posting RHC and Moto!

Posted: Sat Dec 10, 2011 10:58 pm
by Algonquin
After MF Global, I decided that I would pull my capital from any brokerage at the first sign of trouble. Once I read that IB's CEO (already a billionaire) bought millions of dollars of shares of MF while he was negotiating the purchase, I decided to close my account.

Posted: Sun Dec 11, 2011 2:08 am
by rhc
Just back from a relaxing Sunday brunch with a couple of friends. . . . nice Pecan pie that!
The topic of MF Global, Lehman Bros, Bear Stearns & dodgy brokers in general came up.
w.r.t. a concern regarding Interactive Brokers, one friend suggested taking out an ‘Insurance policy’ on a default by IB in the form of a purchase of long-dated-deep-out-of-the-money put options.
You treat these puts exactly the same as you treat your Home Insurance, your Health insurance, your Car insurance etc. It’s a cost paid now for peace of mind and if disaster were to strike you are covered to some degree.
You’re not trying to make money from any of your insurance policies, especially your ‘IB put insurance’. It’s there for your protection in case the SHTF. In fact you hope that these options will always expire worthless.
Cost of this 'insurance' is of course tax deductible

Whether this strategy is feasible or not I don’t know since I am not an Options guy and have no idea of fair value for these kind of things at the various strikes & the various dates.

You would also need to consider how much coverage you need to take out relative to the account size you want to protect & what percentage move the option would make for a given percentage move in the stock.
In other words you might have to know your ‘Greeks’ to understand the behaviour of the option

Any comments from any Option traders out there?
As stated above, is this a feasible strategy?

For the amusement of Forum members here’s a list of long dated put quotes on IB stock from yahoo finance.
Note that IB stock closed Friday at a relatively healthy $15.15

Note also the low volume & OI and the very wide bid/ask spreads . . . . and picture a truck driving straight through them.

Posted: Sun Dec 11, 2011 6:45 am
by Moto moto
if working out that you want to protect a certain amount - ie; your balance at a broker, then OTM options may not be the only choice.
You just need to be able to protect enough to say - if bankruptcy occurs how do I make X dollars.
So you could actually buy far less options that are closer to the money.
These might actually then make you money at some stage as well rather than just expiring worthless.
eg; say you had bought some long dated ATM options at $20. enough to cover your account. While IB has not gone bankrupt, you still might have made money on it.....and can now roll to a different strike and expiry.
Now this might be a trade off about what you are willing to pay for the this insurance....but it may not as you are not trying to actually make money, you are also not trying to cover an amount of are just trying to cover a dollar amount. (if this makes sense) This way you dont actually need the greeks....just one of those deceptive payoff AT EXPIRY diagrams where the greeks will be known.

Just make sure you dont buy the options using the same broker!
and I miss those lazy lunches in summer time of Oz. :)

Posted: Sun Dec 11, 2011 7:29 am
by rhc
Moto moto wrote: I miss those lazy lunches in summer time of Oz. :)
Yeh, it's a dirty job . . . but someones gotta do it!

Thanks for the food for thought re: options. Much appreciated.

Posted: Sun Dec 11, 2011 10:43 am
by 7432
you don't need the long dated insurance, you can just go out 6 months and keep rolling.

a couple items in the original thomson reuters article make things a little scary. in the off balance sheet section counterparty risk is written about, reminds me of the aig conference call before they crashed. the aig people were confident their system of tranches protected the investments as a whole, and it reads like re-hypothecated collateral being churned is going to end in the same fashion.
then there's the list of hyper-hypothecation at the end.
I'm thinking a default or mistake or just business as usual will cause a chain of failures not just by brokers but banks too.
so it might not matter if I own IB puts at wells fargo and wells fargo puts at IB, they all go under at once and I'm left standing in line with other creditors 10 years down the road.

Posted: Sun Dec 11, 2011 12:20 pm
by Chuck B

Re: Interactive Brokers & Re-hypothecation

Posted: Sun Dec 11, 2011 7:33 pm
by rhc
rhc wrote:When/If that official denial comes then we can turn up the Panic dial one or two notches
Chuck, thanks for the 'heads-up' . . . . 'Panic dial' has been turned up one full notch.

Posted: Sun Dec 11, 2011 8:54 pm
by Kiwi
Actually, forgetting the hype the letter is worth reading and thinking through.


Below the response we have put forth regarding the Thomson Reuters article:

Recently, much has been written about the safety of customer assets held by brokers and we believe that customers are justified in their concerns. And so, we are writing to help clarify your understanding of how brokers are permitted to operate and, in particular, how Interactive Brokers protects its customers assets while servicing their needs to trade on margin.

To start, and so as not to leave any confusion as to the position of IB vis-à-vis the Thomson Reuters news article, IB DOES NOT, in any way:

1. Circumvent U.S. securities or commodities rules at the expense of our customers;

2. Invest customers’ segregated funds in foreign sovereign debt or utilize in-house repurchase agreements;

3. Commingle or utilize customer segregated assets for proprietary operations;

4. Enter into agreements which are designed to take advantage of supposedly unrestricted U.K. re-hypothecatio n rules; or

5. Engage in transactions deemed as “hyper-hypo thecationâ€

Posted: Mon Dec 12, 2011 12:59 pm
by Chuck B

Posted: Tue Dec 13, 2011 3:30 am
by Moto moto
from that ET thread.... 44

Here is the link for the updated strength and security info on our site as a number of other items, such as the banks used for client funds, are addressed.


Posted: Tue Dec 13, 2011 5:13 am
by rhc
Moto, couldn't seem to get that link to work.
Tried this instead
http://individuals.interactivebrokers.c ... bgStrength

It's a reassuring read that's for sure

Posted: Tue Dec 13, 2011 1:34 pm
by Eventhorizon
I find ZH's blog site to be fun and all, but whoever writes it has a penchant for hyperventilating.

Let's be clear, without hypothecation you couldn't extend margin loans to clients. Do you expect the broker to lend their own capital to you so you can buy assets with their money? Of course not, they wouldn't have sufficient capital. They borrow the money to lend to you so you can buy assets with money you don't have. What do they use for security for the money they borrow? They use the same assets that are securing your loan which is why it is called re-hypothecation.

In the US the leverage allowed is relatively low: To use the example in the Reuters article that is the basis for the ZH article: I deposit $300 and buy $500 in assets i.e. I have borrowed $200 from the broker, secured with $500 of assets. Leverage is 40% - the assets have to drop by 60% for the broker to take a loss. Obviously my position would be liquidated well before that time - probably when my leverage reached 50% (assets have dropped to $400). I have hypothecated $500 to my broker.

My broker, in turn, is allowed to borrow 140% of my liability to him: $200 x 140% = $280. So he goes to his prime broker or his bank and can borrow up to $280, pledging the $500 in assets as security. The leverage is 56% - higher than mine, but the broker has thousands of clients (theoretically) diversifying the risk. He now has an extra $80 ($200 was used to settle the purchase of the $500 in assets) to invest in supposedly secure assets, earning a return.

The problem, it seems, is that there is nothing to stop the hypothecation process being repeated. It only takes a couple of steps before the net liability exceeds the value of the underlying assets. This part I am not clear on, however. I am guessing it is something like this: the $280 liability is re-hypothecated to borrow $392, and re-h'd again for $549, etc.

I imagine this was made possible via negotiations between regulators and the industry. The regulators only imagined that the broker would borrow from the bank and that would be it; one step, one hypothecation. Unintended consequences at its finest.

An alternative way it could have been done is to say the broker actually has no ownership interest in the $500 in assets, they belong to the client. The only asset the broker has is the margin loan to the client, and the broker cannot borrow more than however much a bank is willing to lend against that loan. Problem is that is shitty collateral and no-one would lend without the underlying as security.

If the rules were: you can only hypothecate once, the investment bankers would simply set up a chain of entities so a different security is transacted at each step, but only once!

Perhaps the best solution is to limit the total principal of loans in the hypothecation chain to some fraction of the value of the underlying.

Posted: Tue Dec 13, 2011 5:44 pm
by Moto moto
Eventhorizon.....I think you nail the issue. It is normal and has always been around for most margining requirements.
In the US there are regulations regarding the limitations to the rehypothecation. When it is transferred to the UK, its theoretically unlimited.

I always knew rehypothecation goes on and that most clients get comingled together (as an option market maker you often needed a lot of leverage even if your exposures were small, and 10-20 times was very normal. You just depended a lot on the clearers risk controls for all the clients)....and was surprised at how many people actually did not know this. What I did not realise was the extent of the continued leverage especially the UK leg of it when it has few limitations. Thats when it gets scary.....and the reason why when a company takes money internally even with all the best intentions there is a lot of trust going on. MFG springs to mind.

I think IB are doing their best to educate clients about rehypothecation and calm markets that they have little risk on in this regard. However the point for me is to limit any money held at any one firm now.

I also wonder ...when clawbacks occur.....can they occur only when someone has withdrawn money as they think the firm is at risk. If you make a habit of withdrawing money as part of your own business it would be hard for any one to argue they can claw it back as you were worried about a; you set a precedent of normal behavior for yourself.
Anyone have thoughts on this?

Posted: Mon Jul 30, 2012 9:08 pm
by stopsareforwimps
rhc wrote:In fact you hope that these options will always expire worthless. Cost of this 'insurance' is of course tax deductible.
I checked the spreads the other night. In fact I nuked my paper trading account by buying $10k worth of $3 OOTM options "at market". The spread on the longest $3 put was 10c-$1, so I had an immediate paper loss of $10k. Closer expiries were not appreciably better. Paying $1 for $3 worth of bankruptcy protection would cut into my returns significantly.

Possibly if I put in a real bid in a real account, market makers may appear with some better offers. Can anyone with options expertise offer an opinion on this?

Does anyone know if the "last sale" quoted on Yahoo is likely to be a real trade? I know in the past I have been misled by synthetic "prices" that never happened.

There was a suggestion to buy at the money puts. The problem I see with this is that if IB's price goes up I lose a *lot* of money. There may be ways to synthesize an OOTM put via other combinations.

Posted: Tue Jul 31, 2012 7:28 am
by Moto moto
Re option pricing....if you dont have access to option pricing models, this one can be used in a simplistic manner. ... sheet.html

I would not rely on most exchange traded, and certainly not on yahoo "last sale" for options. The last sale might have been 3 months or $3 ago.
Depending on who you are using, most paper accounts should have the live spread prices - and yes the market makers have wider spreads in things that are illiquid than they should IMHO - but as it is so computerised these days and the exchanges want them to quote masses of rarely traded options, they have to make them wide....however everything should be negotiable with real orders.

As for what they might be - rule of thumb - take the same months at the money option implied volatility, add about 25% for the OTM vol skew (eg; ATM vol 22%, OTM =22+(22%*.25)=27.5% - This might give you a reasonable theoretical offer price.
(every stock and situation will be different of course), but a 10c, $1 spread is a joke.
All you can do is then watch and wait to see if this is correct, and place a bid order at abut 23% and slowly edge it up. Maybe you get lucky. (Remember that the stock may rally and your implied goes from 23% bid to 27% bid, which then may become attractive if you look at it from an absolute $ insurance POV)

Re other simple strategies - all may involve some sort of risk, and or cost, dependent on where the underlying is during expiry. however as possible ideas to insure your account from calamity....
put ratios - buy 2 OTM, sell 1 ATM
also can be spread over various months. eg; buy 9 month, sell 3 month x3
collars - sell call spread (limit upside risk), buy puts (risk on upside - but possibly paid for it the stock never rallies or sits still)

when it comes to buying the ITM/ATM v OTM, remember that you are not trying to make money, just make enough to cover the lost margin held at the broker, should the underlying go to zero, hence the number of puts purchased should in likelihood be fairly small, and yet diversification is really the only 'cheap' option.