Syed Shah generally buys and sells stocks and currencies through his Interactive Brokers account, but he couldn’t help but try his luck at some oil trading on April 20, the day prices plunged below zero for the very first time. The day trader, working from his home in a Toronto suburb, thought he couldn’t lose because he spent $ 2,400 on crude at $ 3.30 a barrel, then 50 cents. Then came what looked like a lifetime affair: buying 212 futures on West Texas Intermediate for an astonishing penny each.
What he didn’t know was that the first oil journey into negative prices had broken Interactive Brokers Group Inc. His software couldn’t cope with this pesky negative sign, even if it was still technically possible – even if it was a weird idea before the pandemic – for the crude market upside down. Crude oil was actually around $ 3.70 a barrel when Shah’s screen was 1 cent. Interactive Brokers never priced it below zero, with oil continuing to plunge to end the day at $ 37.63 a barrel.
At midnight, Shah received the devastating news that he owed Interactive Brokers $ 9 million. He started the day with $ 77,000 on his account.
“I was in shock,” said the 30-year-old in a telephone interview. “I had the impression that everything was going to be taken away from me, all my goods.”
To be clear, investors who had been in these oil contracts for a long time had a brutal day, regardless of the brokerage in which they had their account. What sets Interactive Brokers apart, however, is that its clients were flying blind, unable to see that prices had become negative, or in other cases, locked in their investments and blocked from trading. The problem, and one of the main reasons why Shah lost an incredible amount in a few hours, is that the negative numbers also blew up the model that Interactive Brokers used to calculate the amount of margin – aka guaranteed – which customers needed to secure their accounts.
Thomas Peterffy, president and founder of Interactive Brokers, explains that the trip to negative territory revealed bugs in the company’s software. “It is a $ 113 million error on our part,” said the 75-year-old billionaire on Wednesday. Since then, his company has revised its maximum loss estimate to $ 109.3 million. It was a moving target from the start; on April 21, Interactive Brokers estimated that the incident had decreased by $ 88 million.
The clients will be well, said Peterffy. “We will return to our equity our clients who were stuck with a long position during the period when the price was negative for any loss suffered below zero.”
It could help Shah. The day trader from Mississauga, Canada bought his first five contracts for $ 3.30 each at 1:19 p.m. on this historic Monday. In the next 40 minutes, he bought 21 more, the last for 50 cents. He tried to place an order at a negative price, but the Interactive Brokers system rejected it, so he became more convinced that it was not possible for oil to go below zero. At 2:11 p.m., he placed this dream job that had become a penny nightmare.
It wasn’t until later that night that he saw the news that oil had plunged to the unmatched price of $ 37.63 a barrel. What does this mean for the hundreds of contracts he bought? He desperately tried to contact corporate support, but no one could help him. Then this late evening statement arrived with a loss so large that it was expressed with an exhibitor.
The problem was not limited to North America. Thousands of miles away, Interactive Brokers’ client Manfred Koller encountered problems similar to those encountered by Shah. Koller, who lives near Frankfurt and trades from his personal computer on behalf of two friends, was also unaware that oil prices could turn negative.
He bought contracts for his friends on Interactive Brokers that day for $ 11 and between $ 4 and $ 5. Just after 2:00 p.m. New York time, his trading screen froze. “The price stream has gone black, there have been no more offers or offers,” he said in an interview. Yet, as far as he knows at this point, according to his Interactive Brokers account, he had nothing to fear because trading was closed for the day.
After the carnage, Interactive Brokers let him know he owed $ 110,000. His friends were completely wiped out. “It’s certainly not what you want to do, lose all your money in 20 minutes,” said Koller.
In addition to blocking due to negative prices, a second issue related to the amount of money that Interactive Brokers needed to have on hand in order to trade. Known as margin, it is an essential risk measure to ensure that traders do not lose more than they can afford. For the 212 oil contracts that Shah bought for 1 cent each, the broker only asked his account for $ 30 margin per contract. It’s as if Interactive Brokers thought the potential loss to buy a penny was a penny, rather than the almost unlimited setback that negative prices entail, he said.
“It looks like they didn’t know it could happen,” said Shah.
But it was known in the industry that CME Group Inc.’s benchmark oil contracts could become negative. Five days before the chaos, the owner of the New York Mercantile Exchange, where the exchanges took place, sent a notice to all of his clearing houses informing them that they could test their systems using negative prices. “Starting today, companies wishing to test such negative futures and / or strike prices in their systems can use the” New Version “of CME” test environments for crude oil, said the stock market.
Interactive Brokers has received this notice, said Peterffy. But he says the company needed more time to upgrade its trading platform.
“Five days, including the weekend, with the coronavirus underway and a complex system where we have to make many changes, it was not enough,” he said. “The idea that we might have bugs is not, in my opinion, a surprise.” He also acknowledged the error in the margin model used by Interactive Brokers that day.
Peterffy says clients have long held 563 oil contracts on Nymex, as well as 2,448 related contracts listed in another company, Intercontinental Exchange Inc. Interactive Brokers plans to reimburse $ 18,815 for Nymex and $ 37,630 for ICE, according to a spokesperson. .
To give an idea of the distance from the Interactive Brokers margin model that day, transactions similar to what Shah had placed would have required $ 6,930 per margin transaction if he had placed them on the Intercontinental Exchange. That’s 231 times the $ 30 Interactive Brokers billed.
“I realized after the fact that the margin for these contracts was very high and that these transactions should never have been processed,” he said. He did not sleep for three nights after receiving the $ 9 million margin call, he said.
Peterffy accepted the blame, but said there was little liquidity in the market after the prices went negative, which could have prevented customers from leaving their trades anyway. He also assigned responsibility for trading and said the company had been in contact with the industry regulator, the Commodity Futures Trading Commission in the United States.
“We called the CFTC and complained bitterly,” said Peterffy. “It seems that the exchanges are going on without scot.”
Representatives from CME and the Intercontinental Exchange declined to comment. A spokesperson for the CFTC did not immediately return a request for comment.
The fallout for retail investors like Shah and Koller raises questions about whether they should have been allowed to take a position in oil contracts just before their expiration, putting them in the position of having to take possession of barrels of crude oil . Since that day, brokers have sought to protect clients, especially those with small accounts who are clearly unable to take delivery physically. Some, including INTL FCStone, have already prevented some customers from touching the oil futures contract for the first month.
Peterffy said that there was a problem with the way the exchanges design their contracts, as the exchanges dry up as expiration approaches. The May oil futures contract – the one that turned negative – expired the day after the historic fall, so most of the market had gone to the June contract, which expires on May 19 and is currently trading in – above $ 24 per barrel.
“This is how it is possible that these contracts could go absolutely crazy and be concluded at a price that has no economic justification,” said Peterffy. “The question is, who is responsible?”