Wednesday, September 14, 2005

When good trades go bad!

I haven't felt like writing lately. I've mainly just been busy, and when I haven't been busy I haven't been able to think about anything to say. To get back into the swing of things I guess I'll just write about the interesting thing that happened with my AAPL trade today. Yesterday APPL sold off and seemed to be recovering. At that point I decided to try to leg into a free butterfly. First I purchased the wings of the butterfly, by buying the AAPL October 45 calls and the 55 calls. Then I put in a GTC (Good 'Till Cancelled) order to sell short the October 50 calls. My reasoning was that AAPL seemed to be moving up so I entered the bullish portion of the butterfly first. The over-all plan was to take some directional risk for a short period of time, in an attempt to build a risk-free trade at a later period of time.

Unfortunately AAPL stalled out and did not continue to go up, and thus my limit order to sell the body of the butterfly remained un-executed. My plan for today was this. If AAPL was up, I was going to give my GTC limit order to sell the body of the butterfly more time to work. If the stock was down, I was going to hedge my delta at the end of the day. This would lock in a loss, but I would still have the oportunity to either profit from a major move to the downside or still get into my butterfly at a good price if AAPL moved up enough, although I would probably no longer attempt to get into the butterfly for free.

When I woke up this morning AAPL was only down a few cents, so I was waiting to hedge my delta. I noticed the S&P started to sell off, and AAPL was trading a little below where it had been most of the day, so fearing a sell-off, I sold enough AAPL shares short to get to delta-neutral earlier than I planned. I still left my GTC order open to sell the body of the butterfly. It appears in hind-sight that my instinct to hedge was a good one since AAPL almost immediately sold off hard for over a buck just after I filled my order. I need to resist patting myself on the back for my great trading though, because more than likely I was just lucky.

The position is now basically equivielent to a long 45/55 combination (long strangle) that I have paid around 80 cents too much for. If AAPL has another day or two like today the position will probably be profitable. At that point I will have to decide whether or not to close the position or whether to adjust again.

A strange thing happened though. I had also been trying to leg into a bear credit spread in DJ all day today. I had sold short the OCT 40 calls, and I had an order to buy the Oct 45 calls to complete the spread. The position was working for me very nicely. DJ sold off slowly all day. Near the end of the day I noticed that DJ was now at a price where my order to buy the oct 45 call should be executed, but the order wasn't there and I had no position! Then I noticed that my Oct 40 short call position had been covered! Furthermore, my GTC order to sell the AAPL Oct 50 calls was also cancelled. I checked the executions page and sure enough there was an order to buy back the Oct 45 call that had been executed, but I never entered any such order.

Here's what I think happened. Even though I had plenty of excess liquidity in my account, I think I got a margin call (Interactive Brokers doesn't actually issue margin calls, they just liquidate your positions automatically) and this is how I think it happened. It has definately seemed in the past that some sort of margin check happens with open orders. It's not exactly clear how un-executed orders affect the margin calculation but I have noticed in the past it does have some effect in that Interactive brokers will cancel some of your orders automatically if executing all of your orders would exceed your margin requirements. (Often when legging into spreads I temporarily use more margin than the actual spread will use once it is completed.)

When I shorted my AAPL shares I used up some margin, although the account page showed that I still had plenty of margin left. I think what happened was that the GTC order in the system was affecting my margin maybe? My assumption is that that AAPL GTC order somehow affected my margin and caused that order to buy the DJ 45 Call to get cancelled. The strange thing is how did my DJ 40 Call get covered? It seems surprising that an open order would actually cause a liquidation. Even with the naked DJ 40 calls I still had plenty of margin as far as I could tell. Whatever happened it is very frustrating. The execution of the purchase of the 45 call would have greatly reduced my margin usage, and the DJ trade was going well. Furthermore my GTC order to sell the AAPL 50 calls had 0 chance to get executed so if that triggered this liquidation then that really sucks. If the order to sell the AAPL 50 calls had become even close to getting executed I would have long since covered my AAPL short position...which would also have greatly reduced my margin. Looking on the bright side, I guess I can be happy that the liquidation of the DJ trade did result in a decent day-trading profit...

I have an email in to Interactive Brokers asking for clarification of what happened. At any rate I think I learned a lesson today to not have too many large open orders.


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