Interactive Brokers’ Costly Failure to Account For Negative Oil Prices

Published On June 5, 2020

The Covid-19 pandemic continues to adversely affect the world’s economic state, causing some extreme fluctuations in prices that complicate the investor’s prospects who usually buy and sell through a number of stable broker services. Since the Coronavirus has tossed everyone into uncharted territory, many of these brokers could not and have not adjusted their platforms to account for such radical changes, leaving many investors vulnerable to bad investments and on the hook for immense collateral costs. Such inconsistencies recently revealed themselves when crude oil prices dropped to astonishingly low rates, before reaching well into the negatives for per barrel pricing, which most broker services were not accounting for. 

Bloomberg reported how one Toronto native, Syed Shah, who typically only invests in stocks and currencies using his Interactive Brokers account, decided on April 20th to try oil trading. As the market price plummeted to below zero for the first time ever, he assumed, like many other investors, that the low prices would ensure a massively successful return on his investment. His initial $2,400 payment picked up oil at $3.30 a barrel and then 50 cents per barrel, before purchasing 212 futures contracts on West Texas Intermediate for the inconceivable price of just a penny each. Unbeknownst to Shah, the Interactive Brokers Group software wasn’t equipped to comprehend negative values, as they had never been seen before the pandemic, failing to display subzero prices that were instead recorded at one cent when they eventually reached minus $37.63 a barrel. 

At midnight, Shah got the disastrous news that he owed Interactive Brokers $9 million, “I felt like everything was going to be taken from me, all my assets.” he told Bloomberg, revealing that he started the day with $77,000 in his account. While many oil contract investors suffered losses regardless of their brokerage, Interactive Brokers Group Inc. especially dropped the ball by permitting their customers who could not see the actual negative prices to make blind payments, in addition to locking in investments and blocking them from trading. Aside from the inability to see true costs, the main reason Shah lost millions in just a few hours is that the negative numbers inhibited the model Interactive Brokers used to calculate margins, leaving customers with massive collateral required to secure their accounts. 

Frankfurt resident Manfred Koller ran into the same problem when using Interactive Brokers to trade on behalf of two friends without realizing that oil prices could and had gone below zero. That day he’d bought contracts first at $11 and then between $4 and $5, but after 2 p.m., his trading screen froze, which he assumed was due to trading closing for the day as his account provided no alerts. Later that day Interactive Brokers sent him a notice that he owed $110,000, completely wiping out his friends, “This is definitely not what you want to do, lose all your money in 20 minutes,” Koller told Bloomberg. Once again, the broker’s margins were miscalculated by the platform, inaccurately informing the customer he owed much less collateral when the reality was there was unlimited downside that negative prices imply. 

Thomas Peterffy, the billionaire chairman and founder of Interactive Brokers, acknowledged that his company had not adapted its systems in time, “Five days, including the weekend, with the coronavirus going on and a complex system where we have to make many changes, was not a sufficient amount of time,” he said, admitting that there were technical errors in the margin model. He accepted the blame for his company’s role in the miscalculations, but also laid responsibility on the exchanges, claiming to be in contact with the industry’s regulator, the U.S. Commodity Futures Trading Commission.

“It’s a $113 million mistake on our part,” Peterffy told Bloomberg, adding that the drop to negative territory forced the firm to revise its maximum loss estimate to $109.3 million. Peterffy promised to, “… 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.” Here’s how far off the model was that day: similar trades to those that Shah placed would have required $6,930 per trade in margin if placed at Intercontinental Exchange, which is a whopping 231 times the $30 Interactive Brokers charged. In his explanation, Peterffy said there’s a problem with how exchanges design their contracts because the trading dries up as they near expiration, meaning that 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.

“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?”