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Thousands of retail option traders who made prescient bets against shares of Signature Bank and Silicon Valley Financial Group, the parent company of Silicon Valley Bank, were relieved on Tuesday this week when shares of both failed banks resumed trading again on over-the-counter markets after a roughly two-week trading halt.
It marked the end of what one academic described as one of the more interesting episodes since a boom in retail option trading began in early 2020, around the time that the COVID-19 pandemic started.
Since the end of 2019, average daily trading volume in all U.S. equity options has doubled to more than 20 million contracts changing hands per day as of the end of 2022, according to data provided to MarketWatch by options exchange Cboe Global Markets.
Faced with the prospect that their would-be winning positions might be proved worthless because of a technicality, traders turned to social-media platforms like Reddit and Twitter for answers and support.
A social-media pressure campaign ultimately helped to push some brokers to help to make customers whole. Even afterwards though some traders were left with huge margin-call balances that left them potentially exposed to tens, if not hundreds, of thousands of dollars of risk.
MarketWatch based its account of this episode on interviews with four traders who were affected due to put options they held on SIVB
SIVBQ,
or SBNY
SBNY,
as well as documents and comments from various brokers — along with a review of interactions on Twitter and Reddit.
Turning to Twitter for answers
Traders initially found themselves in limbo after the Options Clearing Corporation suspended inter-broker settlement for options on SBNY and SIVB, essentially leaving brokerages to deal with customers’ individually.
While the OCC’s statements stipulated that settlement for expiring options would be delayed, it offered little insight into how options traders could move forward.
The OCC didn’t return a request for comment from MarketWatch.
Since Silicon Valley Bank and Signature Bank had been placed into FDIC receivership, traders felt that their options should be worth their maximum value as shares in both companies would likely become worthless, traders said. The only problem was trading in both companies had been halted, making it impossible for brokers to accurately value option positions.
Brokers initially were content to allow all options to expire worthless. Communications with brokers’ help desks initially showed platforms were unable or unwilling to help customers exit their positions, meaning those with winning bets might see them expire worthless, while those on the other side of the trade would be spared punishing losses.
A significant amount of money was at risk. To wit, a Bloomberg News report estimated the value of put options on SBNY and SIVB expiring on March 17 at nearly $300 million, assuming the market value of both companies plummeted to effectively zero, which eventually happened. Shares of both banks were trading at just a few pennies on Wednesday, according to FactSet data.
Massive margin balances
But even after some brokers decided to try and help customers, some traders were left with massive margin-call balances, keeping them on edge until the shares started trading again, according to interviews with MarketWatch.
Robert Bogan, a health-care IT analyst from Miami Beach, briefly carried a margin-call balance of nearly $179,000 for more than a week in his Robinhood account after his puts against Signature Bank were converted into a short position in the company’s shares marked at the most recent closing price of $70.
While he waited for SBNY shares to start trading again, his daughter was born a few weeks premature to a surrogate in Colombia.
“Honestly, if I didn’t have savings, I would be freaking out right now. I can only imagine what other investors who aren’t in my situation are going through.”
Fortunately for Bogan, he managed to close out his position for a six-figure profit once shares of SBNY saw their value declined by more than 99% when they reopened on Tuesday, according to FactSet data.
Bogan and others credited short seller Marc Cohodes, who has a large following on Twitter, with helping to pressure brokers to work with affected customers. With Cohodes’ help, Bogan was connected with the Norton Law Firm in Oakland, Calif., according to a document he shared with MarketWatch.
On March 15, Robinhood Markets co-founder and CEO Vlad Tenev responded to one of Cohodes’ tweets calling for action by saying “we’re working to resolve this ASAP.”
A communication sent shortly afterward by Robinhood to affected customers included instructions about how to exercise their puts, as well as an explanation about the potential risks that accompanied carrying a large short position on shares of a halted stock. Many traders would be hit with large margin-call balances, the exchange explained. And while many assumed shares would eventually be marked worthless, there were no guarantees.
“We have no indication where SIVB will open again, or if trading will even resume,” said the communication from Robinhood seen by MarketWatch.
At least three brokers Robinhood, Interactive Brokers and Tastytrade made an effort to allow customers to exercise their puts before they expired, according to interviews with traders and executives, as well as documents seen by MarketWatch.
A representative for Schwab, which owns TDAmeritrade in addition to Schwab-branded brokerage accounts, said their platforms allowed customers who were “able to meet the requirements” to exercise their puts, although they didn’t elaborate on what these requirements were.
Robinhood declined to comment further, while Interactive Brokers confirmed that it allowed customers to exercise puts on the day of expiration if they asked the broker to do so.
What’s a put?
A call option gives the owner the right, but not the obligation, to purchase a lot of securities at an agreed-upon price, known as the strike price, on or before the contract expires. A put option gives the holder the right, but not the obligation, to sell.
A “short” is a trading strategy that involves borrowing shares of stock from a broker and then selling them in the hopes of buying them back later at a lower price. If the price has indeed fallen, a trader can book a profit based on the difference in price minus whatever fees they paid to borrow.
When shares of Silicon Valley Financial and Signature Bank of New York were halted, brokers faced a dilemma.
Either they could allow customers’ puts — options that in many cases should have represented winning bets — expire worthless based on what was widely perceived to be a technicality, or they could placate customers by allowing them to exercise their options and carry a short position in the underlying stock, assuming they could source the shares.
Further complicating the situation was the fact that many retirement accounts like IRAs where option trading is allowed are prohibited from carrying short positions in a companies’ shares.
Scott Sheridan, chief executive of electronic brokerage Tastytrade, told MarketWatch during a phone interview that his company allowed customers holding puts on SBNY and SIVB to exercise them “on a case by case basis.”
“They didn’t have to have all of the margin, but as long as we felt they had a reasonable amount of net liquidation value in their accounts, we were okay with the risk,” Sheridan said.
Practically all customers holding puts were able to exercise them, he added, and Tastytrade had little trouble sourcing the shares it needed to lend to customers.
Option traders typically trade on margin, meaning they can open positions with money borrowed from brokers, so long as their accounts have enough cash to cover a set amount of potential losses.
If the value of an account falls below this designated risk level, the customer is issued a margin call demanding they wire more money or risk having their account liquidated and their cash seized to cover their debt.
Although Robinhood did issue margin calls to customers like Bogan and others who spoke with MarketWatch, the broker said it wouldn’t liquidate affected customers’ accounts, although they were effectively frozen as a result.
Echoes of ‘the Big Short’
Nick, a longtime option trader based in Los Angeles who spoke with MarketWatch and asked that his last name be withheld because of his work in the financial-services industry, briefly carried a negative margin balance of nearly $80,000 in his Robinhood account after the brokerage converted his SBNY puts into a short position.
Nick’s winning bet against Signature Bank followed several months of trying to bet against banks like Signature and Silvergate Bank that had close ties to the cryptocurrency industry. After months of carrying losses, the implosion of Silvergate and run on Silicon Valley Bank inspired him to buy shorts on Signature.
But on March 13, when Nick first realized that he might not be able to exercise his put options despite correctly anticipating Signature’s collapse, he was reminded of a famous scene from the movie adaptation of Michael Lewis’s novel “the Big Short.”
In the scene, the character Mark Baum, played by actor Steve Carell, worried that his bets against mortgage-backed securities might ultimately prove worthless if his counterparties — that is, the other traders he was betting against, in this case major U.S. investment banks — went bankrupt before he could collect his winnings.
Fortunately for Nick, that’s not how things played out. He ultimately booked a profit north of $100,000 when he closed his short position on SBNY on Tuesday, he said. Once he found out shares of SBNY would resume trading, he celebrated by booking a trip to Disneyland.
“For me, this is life-changing,” he said during a phone interview.
A lesson learned
Shaun William Davies, a professor of finance at the University of Colorado who teaches a class about derivative securities, found himself caught up in the confusion after buying puts against SBNY that expired on March 17.
Initially, Robinhood told him there was nothing they could do if the shares remained halted.
But after the broker helped him to exercise his puts, he found that the roughly $30,000 in his account was enough to offset the negative margin impact according to account details he shared with MarketWatch.
Since Davies has a PhD in finance, he couldn’t help but worry about what might happen if SBNY’s shares remained halted for too long.
Specifically, he worried that brokers like Robinhood might need to start charging customers’ fees to offset the drain on their liquidity as a result of having so many traders carrying short positions and negative margin balances.
“As a financial academic I was intrigued,” he said during a phone call.
He said the incident ultimately helped to “expose some cracks in these discount brokerages” as they work to enable more customers to trade options. Options are typically more lucrative for brokers since they involve wider bid-ask spreads, which brokers make money on.
Robinhood and its rivals also charge fees on options trades while many discount brokers offer free trading in stocks and exchange-traded funds, a practice that was pioneered by Robinhood.
Ultimately, Davies said, the incident made for an interesting case study for his students, whom he said were following his situation with interest.
“They’re living vicariously through me and my pain,” he said.
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