Oil crash busted broker’s computers and inflicted big losses(bloomberg.com) |
Oil crash busted broker’s computers and inflicted big losses(bloomberg.com) |
Ironically this is the same guy who will sell you a gym contract without a cancellation option and blame you for not doing your research when you owe him $1100.
Thomas Peterffy must think we are idiots. Anyone who trades commodity contracts for any period of time knows that the real cost of the contract is the actual cost of the commodity - storage costs. When storage costs spike and the actually commodity spot costs go down, the future will become negative!
One way to get a handle on storage costs is think of them being inversely proportional to the value density. The higher the value density, e.g. gold the less the storage costs. Oil is not so dense so storage costs matter. Financial instruments like the Treasury Bonds and the S&P futures contract have zero storage costs. Storage cost is of-course different than carry cost (the cost of funding your long position).
On another aside, I have known folks who have worked at IB in the past, and their systems absolutely suck dead goats. Huge masses of legacy C++ code with poor testing. Most of these brokerage firms have legacy code base from the 90s that is poorly understood. They also have nonexistent organizational quotient around code validation, correctness and testing their risk models. A futures margin model is not something one can whip up over a weekend but a good CS undergraduate can program one over a couple months.
Sorry for the IB customers but I have zero sympathy for IB or should I say negative ;)
https://www.cmegroup.com/confluence/display/EPICSANDBOX/Posi...
The CEO also said they would pay $100million to clean up, which is not chump change, even for them I bet.
I'm not saying they were blameless, but I think most systems which have never had a given variable go negative, that years after they were written finally have that variable go negative, will have problems.
If they really cared or if this was as obvious as everyone here is claiming it is, negative price support would be part of their certification suite. It is not.
As a customer I’m not surprised at all. Their software is terrible, especially the simplified web application and their mobile app. Terrible. But their fees are incredibly low. You can convert a million dollar to other popular currencies for less than 20$ at interbank rates. Just nuts.
For my limited requirements, Interactive Brokers does seem to meet needs, but do you know of a platform that is highly regarded that is accessible for clients outside of the States?
Interactive Brokers seemed to tick a lot of boxes at the time when I chose them.
On a serious matter, doesn't Peterffy owns a huge chunk of IB and a brokerage is as riskless of a transaction business as you can get to in the financial industry as possible.
IB's frontends used to lead the market and their pricing is decent too. Who else lost $100 million because they did not program futures and span margin properly?
> “That’s how it’s possible for these contracts to go absolutely crazy and close at a price that has no economic justification,” Peterffy said. “The issue is whose responsibility is this?”
It’s pretty well known that commodity futures contracts are a game of hot potato for most investors as the expiration date approaches. But the Interactive Brokers CEO doesn’t offer an alternative solution. How would the contracts be structured instead that would avoid this? I don’t see how it would be possible.
Interactive Brokers' software is usually very solid. I'm surprised they weren't ready to handle this, the possibility of oil going negative had been discussed for some time before it happened.
[1] https://web.archive.org/web/20200117115242/https://www.cmegr...
[2] https://www.cmegroup.com/trading/energy/crude-oil/light-swee...
Wow, just wow. They are handling millions (billions?) of dollars every day and couldn't find the time to test that they can just DISPLAY a minus sign. That's insane.
And it's not even that outlandish. People were saying it could go into the negative weeks before it happened. This just seems like pure laziness. Just pretend everything is business as usual.
I have a gut feeling that this bug was flagged and closed as WONTDO because "that'll never happen"
It turned out the assumption was wrong and yeah, you should remove the logic handling that once it's evident futures may go negative, and you should have a process capable of making that change with only a day or two notice. But being robust the rest of the time at the expense of mishandling a once-in-fifty-years event is not in itself a bug.
If you disagree, should a trading system also allow negative prices for precious metals futures? Stocks? Currencies? Options? Bonds? Futures on stocks or bonds? I can contemplate all of those trading negative in extraordinary, contrived scenarios but I would design systems today not to trade them at negative prices.
>I worked as a risk manager in a commodity trading firm and only hedgers qualified to take delivery were permitted to hold contracts going to delivery.
Ehh.. what? I've been part of a CTA for many many years, we have trading programs.. our clients trade in our programs.. the entire industry never takes delivery yet trades all these contracts which have delivery (metals, ags, energies). Very confused what you are talking about.. everyone rolls out of these before first notice dates.. brokers are on your back a week before the FND are coming up.
IB fucked up, no doubt, but these idiots are trading shit they know nothing about.
Don't trade on margin.
It's not reasonable for them to expect to deal with a platform that misrepresents the state of the market and executes trades at a non-market price, as was happening here. (It was telling them the oil futures still had a positive price when it was negative, and making them pay on that basis.)
Is it? Isn't this the entire reason risk management departments exist?
There are tons of opportunities in finance to make short-sighted proclamations like "the number of futures in this kind of contract is always 100" or "this type of security can't go negative", and have it be true at the time, but false 5 years later when they add a new type of contract.
My notion is that if much of the trading (and it can be shown by futures volumes) cannot possibly be on actual physically deliverable quantities, then most must be "speculation" by people who cannot actually produce the asset. Would this be a help to stabilize the market?
I know it all has to get settled in the end by the expiration date, but just an idea.
The underlying theme here is that speculators are not providing utility to the market, which is wrong. They are bridging time and risk.
Let's just call it what it is: gambling.
That said, there is an issue here with futures contracts: you can get very very large leverage when the price is near zero. This is the real issue with instruments that can negative price and just like their are “circuit breakers” in markets for big price swings, there should be breakers for entering the “near zero” range.
Futures contracts that CAN BECOME NEGATIVE don't let large leverage when price is near zero, that's NOT TRUE. Future contracts margin is calculated with SPAN, and if it's done correctly, it considers the scenarios where price can go below 0.
It clearly is. If I can buy a contract for 1c, I can get 100,000 contracts for 1000usd. Then if the price rises of falls by 1usd, I'm up/down 100,000 dollars. Can you think of any retail product with that sort of leverage?
That's the danger of putting zero in a denominator.
Volatility has a cost. With oil, it's one that the US and other countries hae historically tried to dampen with various industrial and political methods (the national strategic oil reserve, military/political "influence" on foreign oil producers, subsidies for domestic production), but seems like the current situation is beyond those methods' ability to control.
1. https://www.macrotrends.net/1369/crude-oil-price-history-cha...
2. https://www.energy.gov/sites/prod/files/2015/08/f25/LCOE.pdf
3.https://en.wikipedia.org/wiki/Cost_of_electricity_by_source#...
4. https://en.wikipedia.org/wiki/Cost_of_electricity_by_source#...
Does this pose a risk of IB going insolvent? If they do, is there a risk of their customers being just another creditor of a bankrupt corporation, with respect to the stocks and futures that IB holds on behalf of those customers? Or are those instruments held in bailment, or actually by some other company, rather than as IB assets?
A bit of a design flaw, I wonder did they spend as much money on the software as Equifax did?
if (-3.70 != 1) { send an alert; }
> Customers will be made whole, Peterffy said. “We will rebate from our own funds to our customers who were locked in with a long position during the time the price was negative any losses they suffered below zero.”
I'd imagine this is so they don't get sued and have some shoddy code pop up during trial.
same result of avoiding litigation, but even fewer consequences
I know the monthly spot average of that statistic (fetched from FRED, the Fed of St. Louis system) won't turn negative, but still...
My thoughts precicely, is there anyone on here that could explain the intricacies of these kind of trades?
Looks like Interactive Brokers fucked up in more than one way here.
There are plenty of things to watch out for with these ETFs. You pay ongoing expense fees. And ETFs, especially those that aren't just holding containers for assets, can have subtleties in their prospectuses that cause their value to fluctuate in counterintuitive ways. There's still a lot to be cautious about.
However, compared to the actual futures, they're more suitable for casual investors, for reasons such as what we see here. They can't go below 0 and don't necessarily involve margin. And the ETF will typically deal with things like rolling the futures position ahead of expiry.
Most commodity and leveraged ETFs are designed to benefit just one party - the designer of the ETF. There are plenty of articles on USO and its travails.
This listed as making commodity ETFs more suitable for "casual investors" is the exact reason why they always lose money on ETFs. Retail investors for the most part do not understand contango or backwardation and do not understand (even though it's listed at the beginning of every prospectus) that these are not buy and hold instruments. In fact, I'd argue that it's easier to understand roll costs by actually having to roll futures contracts yourself (which is not difficult at all) vs having it obfuscated away in an ETF.
> They can't go below 0
One month ago people know that futures can't go below 0. What guarantees ETFs will never go below zero? It's economically absurd to think an ETF holding negatively priced assets will still have positive value.
I would argue that if an investor isn't knowledgeable enough to trade an underlying, the investor shouldn't trade an ETF of these.
Very much so. I wrote software for financial traders in the 1990s, and I heard tell of a couple of clerks (in this context, sort of "trader intern") who thought they were smart enough to do a little commodity metal trading on the side. However, they didn't quite understand the details of contract expiration, and so supposedly they ended up with 25,000 pounds of copper delivered to somebody's parents house. Oops!
> Peterffy said there’s a problem with how exchanges design their contracts because the trading dries up as they near expiration. The May oil futures contract -- the one that went negative -- expired the day after the historic plunge, so most of the market had moved to trading the June contract, which expires May 19 and currently trades around $24 a barrel.
> “That’s how it’s possible for these contracts to go absolutely crazy and close at a price that has no economic justification,” Peterffy said. “The issue is whose responsibility is this?”
Nobody ever promised neither liquidity nor positivity of prices, it is the fault of the brokerage, plain and simple. Thankfully $100M is something that IBKR can take on their books (they have $3B of cash according to the latest filling).
That is certainly not my experience. Endless bugs in TWS over the years, and the support people are unbelievably rude. Every time I try to report a bug they start out by blaming me, it usually takes 2-3 back and forth rounds until they admit it's actually broken and tell me they'll forward the issue to the tech people. After that it's radio silence and you never know if they'll actually fix it or not.
And let's not get into the disaster that is their API...
Except their web portal. 40-50% of the time it is unable to load my portfolio data (even without the current market value, just the number of stocks and cash balances). At the same time I log into the mobile app, it forces a logout on the web app (why?) and it is able to load the balances and portfolio. No explanation. Same network, no adblocker or other browser plugin.
The distinction you’re looking for here is those who are speculating on market prices, vs. those who are hedging against market prices. If you use or sell oil in large amounts, it makes sense to use futures to stabilize your downside risk, even if those futures are cash settled.
That being said, I think that cash settled futures make purely speculative trading much easier, so you’d have a good point if that’s what you were heading towards.
Modulo the fact that almost no one a naive observer might accuse of "speculating" is actually speculating, I do agree that speculating on commodities futures is dumb, because taking a directional bet on anything you don't have inside information into is dumb.
What? How is it any more dumb than speculating and buying a stock hoping it will go up?
Speculation in futures is what gives those farmers liquidity in the markets.
Futures is a zero-sum game.. so in my world futures make way more sense to trade than everything throwing money into stocks to magically make money out of thin air until they don't.
Seriously, do people enter into contracts like this in other parts of their life?
That said, it varies by regional availability. For instance, Canada has fewer options: https://www.producer.com/2017/11/hedging-with-u-s-futures-an... To properly hedge a Canadian producer using a US future you’d need to also hedge against the Canadian dollar, presumably. And hope that the weather and such is similar enough.
As for trading exactly the item you will need delivery on, that may be hard to find. Standardising on a contract that's "close enough" allows crude oil producers to trade with airlines, bus companies to trade with refineries, etc, even if they all care about different products.
I thought the commodity was coal. And the issue was that the trader was at a fancy new office park with a river view that was an old dock specifically for coal.
Cheers
"Delivery shall be made free-on-board ("F.O.B.") at any pipeline or storage facility in Cushing, Oklahoma with pipeline access to Enterprise, Cushing storage or Enbridge, Cushing storage."
Source: https://www.cmegroup.com/trading/energy/crude-oil/light-swee...
"The West Texas Intermediate Light Sweet Crude Oil futures contract is cash settled against the prevailing market price for US light sweet crude."
Assuming your broker is competent (which the broker in this story is not), they won't let you buy 100,000 contracts for 1000 USD unless you can cover the potential downside, which would be of millions (possibly tens of millions) of dollars. So you can't actually leverage $1000 into going up for down $100,000; you would be tying up $X,000,000 to go up for down $100,000.
Unfortunately IB was not competent and they did not calculate the margin requirements correctly, which allowed their customers to leverage themselves improperly.
For example, for this contract Bloomber says IB asked for $30 margin. But the margin is usually $7000 for this contract, that it was IB should have requested as collateral at least for each contract. in a day with that volatility should be much higher in IB, as they take that also in consideration, probably around $20000 per contract.
The problem was that IB didn't consider scenarios in which the price can go below 0. The software was designed in that way. But it shouldn't.
Other physically settled commodity contract have different delivery locations, /CL (WTI crude) delivery takes place at a terminal and storage facility in Cushing, OK.
https://www.cmegroup.com/education/courses/introduction-to-b...
In contrast, a futures contract is an agreement to make a future trade, so it can keep going against you past 0. If you are able to take physical delivery, your worst-case scenario is that you pay the money you said you would, and you get your oil. But if you are a casual day-trader type, you probably don't have the ability to take physical, so you may be in trouble (over a barrel, literally).
I agree with you about the dangers of ETFs and about knowledgeability. I didn't mean to advocate for ETFs on an absolute basis, just to make a relative statement about them vs. futures.
My opinion is that ETFs are legalised bucket shops and ought to go away. The Oil Futures market represents an actual need, Alice wants to sell her oil knowing what she'll get for it when it's delivered in a week's time, Bob wants to be able to lock in today's prices for next week's oil. There is clearly a deal to be made there and if people who don't actually need oil want to tie themselves up in it and maybe improve liquidity I guess I won't stop them. But Oil ETFs are just a way to gamble on the value of the Oil Futures, and that's why we forbade bucket shops. Negative future prices show that the mechanisms which are supposed to make ETFs safer than bucket shops are flawed, and IMO too flawed to continue to accept them as a legitimate business.
Effectively the broker lied to them about how leveraged they were.
These are: QM NYMEX, and WTI ICE. Both cash-settled.
QM - https://www.cmegroup.com/trading/energy/crude-oil/emini-crud...
And at least in Chicago in the 1990s, traders and clerks could definitely be wild. During slow periods on the CME floor somebody would get a transparent trash bag, declare it a $20 bag, and then walk around with it. People would write their names on $20s and throw them in. Once they'd made the rounds, they'd shake the bag and have somebody draw from it. I myself saw thousands of dollars change hands like this. And clerks would regularly bet one another about jumping into the Chicago river from Upper Wacker, which is a fair drop.
Or there was one incident that was witnessed by a couple of our traders, as it happened in their pit at the CBOT. One afternoon among all the colored coats, they see somebody in a polar bear costume walking around the trading floor between the pits. One trader turns to another and says, "I'll pay you $100 if you punch the polar bear." The trader thinks about it, takes the $100, goes over, lays out the polar bear, and then in the chaos goes back to his pit. This turned out to be a bad trade, as the polar bear was there as a fundraiser for the Lincoln Park Zoo, and one of the people on the zoo's board was also on the exchange's board. Oops!
But I don't agree that USO is _more_ dangerous for a casual trader to trade than oil futures, for the reasons I mentioned.
Removing the overall fluctuations of the oil market, the relative problem with ETFs is that they bleed away value over time. That's a real issue, but I wouldn't compare that to juggling a live hand grenade.
Edit: you did not say it was more dangerous, my mistake. I do think that ETFs are less dangerous, for the reasons I mentioned.
This, unfortunately (or for some, fortunately) requires understanding the structure of the Oil market and how Oil is bought, sold, delivered and transported and yes stored! Spot prices, futures, oil grades, hubs, contango, etc.
[1] https://www.bloomberg.com/news/articles/2020-04-30/investors... [2] https://oilprice.com/oil-price-charts
USO has unpredictable drift due to contract rolling and often trades at a significant premium/discount to NAV.
Their website: https://www.thetanktiger.com
> The objective of the Tank Tiger is to serve as a clearinghouse and a single point of contact for parties who desire terminal tank services or utilization of midstream assets and to bring them together with the companies who own these assets and seek further utilization. It also provides for tenants who are leasing storage to find subleasing opportunities, when it makes sense for them to do so. Our expertise in this field provides a fast and efficient connection so that the uncertainty of storage availability is eliminated from the supply and trading equation. The Tank Tiger can facilitate and reduce market inefficiencies and illiquidity by providing this service.
Speculators in theory also provide liquidity, and in theory also contribute to keeping the prices "correct" (meaning at levels that reflect what's known). But it's not like any given speculator personally cares about that; they're just looking to gamble and win. Last I heard there was reasonable evidence that more gets spent on speculation than is delivered in benefits to the economy. So you suspicion is not unwarranted.
But there's another class of people who neither create nor consume the product, but have some financial interest in something related. E.g., suppose you sell farm equipment. You know that if wheat farmers have a bad year, you'll have a bad year, because they will put off buying your new tractors. To even things out, you can use wheat derivatives to essentially buy insurance on wheat prices. If wheat prices are normal, you lose a little money. But if they fall through the floor, you make money, hopefully counterbalancing the income from lost sales.
When this activity is significant enough, it can lead to the creation of synthetic commodities. E.g., if you are in the snowplowing business, maybe you want to insure against winters being abnormally snowy. You could maybe do something with a fuel oil future. But that's kinda tenuous. Instead now you can just trade weather futures: https://www.cmegroup.com/trading/weather/
People that want to buy or sell a commodity typically only want to do a certain number of transactions. What happens if they can’t find someone to take the other side of a trade? It would be annoying to have to wait a week until someone else is interested. Moreover, they may want a different quantity than you do, or they may want a different delivery date.
There is also price discovery as you allude to. A farmer selling pork doesn’t necessarily want to have to track the details of the Chinese economy and the weather patterns in Europe just to get a fair price for their goods. Speculators help with that.
E.g. a bread manufacturer wants stability on their cost of goods, so they may buy wheat futures even though they don't ever want to receive direct shipment of wheat, they're dealing with specific regional flour suppliers but the wheat futures at a major location are a good proxy for that price.
I am not justifying inaccurate pricing. Burning speculators is fine, but give everyone accurate information.
Hard disagree. There are lots of reasons people with legitimate hedging concerns who don't intend to take physical delivery prefer the physical contract to a CSC (if it's even available).
Freight industry, airliner, etc.
The issue here is total speculators using PHYSICALLY settled contracts to speculate who don't want delivery.
The number of people who need WTI are pretty few - refiners and some small others. Seriously - with WTI you still need to refine it - airlines CANNOT just load WTI into their tanks.
These sob stories from folks who supposedly were bidding to take delivery of physical oil (unrefined) from a condo somewhere are ridiculous.
To trade futures you need to certify you understand them. I'd love to see the form this guy filled out listing what was likely a fair bit of bogus experience.
I'm fine with all these idiots getting burned.
The freight industry will similarly buy futures in bunker fuel, diesel, or whatever exactly they use to fuel their vehicles. Again, they're not refiners and have no use for raw crude.
It's the oil refiners that buy futures in crude. Well, them and speculators.
* Different regulatory capital requirements
* Some commodities don't have cash settlement
* Sometimes a CSC doesn't count (as much) from a regulatory/insurance perspective if you're hedging a position in a commodities basket or whatever
I'm sure there are more - I don't work in commodities.
After 2008, banks were banned from speculating (ish) [1], but were allowed to do market-making. It's common for market-making desks to do speculative trades under cover of market-making activity. It's hard to conclusively prove that any given trade is speculation rather than market-making (which involves hedging), so they generally get away with it.
It doesn't matter. Airlines absolutely buy crude futures to hedge against changes in fuel cost. It might be impossible to buy futures in the exact good you need, or it might be too expensive due to illiquidity and slippage.
It's like how beer manufacturers buy aluminum futures even though they almost never take delivery on the futures. They're just going to buy the processed aluminum from their regular processed aluminum supplier, but they can still hedge some of the price changes with the easily available physical aluminum futures.
Anyway, as usual, Wikipedia has a relevant article, and it seems that airlines do both: https://en.m.wikipedia.org/wiki/Fuel_hedging
