2008issue C021-4
Protective put sizing under broker insolvency
Archive material on broker failure shows that customers can lose the securities and options themselves, that listed puts can be closed without consent, and that a same-strike stock-and-put package can be reimbursed well below the intended bound. This article treats that sequence as a sizing filter on both market loss and custodian loss.
- In a credit-stress period, brokerage customers can lose access to the securities and options themselves if the carrying firm fails, not only mark-to-market value on those holdings.
- A same-strike protective put can fail to bound loss if the put is liquidated separately and the stock is later reimbursed at a lower filing-date value.
- Statutory per-account protection is described as $500,000 in securities with a $100,000 cash component, and extra firm insurance is often an aggregate policy over all customers.
- Keeping holdings inside the per-account protection cap, opening additional accounts, and moving shares out of street-name custody are presented as ways to keep firm-failure exposure inside a known bound.
Why the package can fail as a bound
A protective put is a long put held against long stock or a similar cash-market exposure so that a decline is meant to be offset by the option.
In a credit-stress period, brokerage customers can lose access to the securities and options themselves if the carrying firm fails, not only mark-to-market value on those holdings. Option closeout risk is the chance that listed options are liquidated without consent, or delayed for exercise or offset, if the carrying firm or its clearing member fails.
What the per-account cap actually covers
Statutory customer-protection coverage for a securities account is described as $500,000 in securities with a $100,000 cash component, and membership should be verified rather than assumed. That pair of ceilings is the per-account protection cap: the stated securities and cash amounts that define how much of one brokerage account is treated as covered if the firm fails.
Extra insurance advertised by firms is often aggregate excess cover, a policy written over a firm's entire customer book rather than a guaranteed floor equal to the headline figure for every account. A single large account can remain only partly covered after a major firm failure.
When the put is closed without consent
If a broker-dealer becomes insolvent, listed-option positions can be closed without the account holder's consent, and remaining contracts can face delay or difficulty when the holder tries to exercise or offset them.
A long stock paired with a same-strike protective put can fail to bound loss if the put is liquidated separately and the stock is later reimbursed at a lower insolvency-filing price. Filing-date value is the price used to value securities for customer reimbursement when a broker-dealer is placed in liquidation. A $100 stock with a $100-strike put sold at $10 while the stock falls to $50 is reimbursed at $60 rather than $110.
Keeping firm-failure exposure inside a known bound
Keeping securities and cash inside the stated per-account protection caps, including by opening additional accounts, is presented as a way to keep firm-failure exposure inside a known bound before entry and while the position is open.
Street-name custody is registration of customer securities in the broker-dealer's name, so the shares sit inside that firm's custody chain. Moving shares out of street-name custody through certificates, transfer-agent depository accounts, or issuer direct registration reduces the quantity of stock sitting inside one broker-dealer failure.
Counterparties outside the securities-account frame
Futures and related cash-management counterparties sit outside the same securities-account insurance frame and have recorded firm failures and alleged misuse of customer funds, so custodian research and diversification apply there as well.
All readings on this track · 15 readings
- 1988Two-sided cheap premium, volatility, and protective puts
- 2000Compare a Protective put and a Stop-loss order before entry
- 2007Sizing options by assignment, spread legs, and portfolio margin
- 2007Fund a put-hedged long by remaining package loss
- 2008Protective put sizing under broker insolvency
- 2008Seasonal regimes, index put overlays, and call-spread mechanics
- 2008Stops, protective puts, and financed spread risk
- 2008Three loss bounds: debit spreads, stops, and protective puts
- 2014Seasonal put spreads for index-linked portfolios
- 2017Option construction after a post-listing drawdown
- 2017A stop-loss is an execution request, not a loss ceiling
- 2018Objective-first construction of hedges and income
- 2018A protective put as a prepaid loss budget
- 2020When a futures gap-open voids stop-loss protection
- 2020Protective put loss budget by strike and tenor