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Raising money — the engine that fuels trade and economic endeavors—has been a concern from the time money was invented in the form of cowries or shells in China around 1500 BC.

China, where paper originates, was the first country to issue paper money around 650 AD, an invention that Marco Polo brought back to Europe in the late 13th century.

Money—paper money, in particular—raised an interesting question: because it is a token, it is worth what people think it is worth, and, therefore, the trustworthiness of the issuer is crucial to uphold its value.

Trust was also a key factor in another form of fiduciary issuance, notes and securities. Known for their wealth, the Italian bankers of the Renaissance had no problem getting their bills of exchange accepted throughout Europe. Active trading in those well-regarded instruments actually led to the foundation of securities exchanges in Europe, although they did not trade stock until two centuries later.

Early examples of commercial entities issuing shares include the Societe des Moulins de Bazacle in southern France, which raised funds by sharing its ownership among 96 certificate holders in 1250. This might well be the longest-traded shares in the world, as the stock of the company was listed on the Paris Bourse until 1946 under its new incarnation as Societe Toulousaine d’Electricite de Bazacle.

But the United East Indies Company (VOC) in the Netherlands is the world’s first corporation to have officially issued shares to the public via a public offering in 1606. With the promise of rich dividends, the VOC raised nearly 6.5 million guilders—a fabulous amount by 17th-century standards for the first initial public offering (IPO).

By issuing stock, the powerful VOC added another notion—expectations of future performance—to the one of trustworthiness of the issuer.

Investors were well rewarded at first, with the VOC paying a 75-percent dividend on profits while the stock surged 3,000 percent. But after nearly 200 years of flourishing business, the mismanaged company eventually went bankrupt and its stock became worthless.

Closer to us, some eager investors in the Internet bubble might have felt the same way. Like any other investment vehicle, stocks require caution on the part of the investor.



Stocks, what are they?

Stocks represent a stake in a company and a proportional claim against the company's assets and earnings as well as voting rights attached to most stock classes.

In reality, shareholders’ chances of collecting anything in the event of the company going bankrupt are more than slim because their claims will come after those of creditors and bondholders. On the positive side, the shareholder is not liable for any of the debt or possible misdeeds of the company.

The main reason for stock ownership is the expectation of capital appreciation—which may or may not occur. The wisdom has long been that equities eventually outperform other investments, meaning it is wise to get into equities and stay there for the long haul, regardless of the market’s ups and downs.

Timing is of the essence, however. Investors who got into the stock market in 1990 and got out in 2000 might have had a great run, but from late 2000 to the present time is another story…

Stock ownership comes in a stock certificate, sometimes a highly attractive document, such as shares in Disney, complete with the mouse that roars. In the digital world, however, brokers keep the document “in street name” and investors receive a bland statement of ownership.

Shareholders have some limited influence on the way the company runs: each share with voting rights carries one vote when it comes to electing the company’s Board of Directors. Shareholders can also voice their criticism at shareholders’ meetings. Of course, large investors—in particular institutions like pension funds—do have a bigger say, such as did Calpers or the California Public Employees' Retirement System, the nation’s largest pension fund, in the case of Disney’s management.

Some companies, in particular the “blue-chips” that are named after casino’s most expensive tokens, pay dividends, the distribution of a portion of a company's earnings, decided by the board of directors to a class of its shareholders.

Companies can do special one-time dividend payments, mostly when this is aimed at reflecting a particular event, such as the sale of a business unit.

Most dividends are paid quarterly. Investors may choose to re-invest the dividends in the company’s stock. Dividend Reinvestment Plans (DRIPs) and Direct Investment Plans (DIPs) are plans where companies allow shareholders to purchase stock directly from the company.

Most secure and stable companies offer dividends to their stockholders. While their share price might not appreciate much because the company’s business model is mature and fully valued, the dividend attempts to make up for this.

High-growth companies usually do not pay dividends because they would rather invest profits into further research and development. Due to a recent change in tax laws, big IT companies, such as Microsoft, have started paying dividends as well.

COMMON AND PREFERRED STOCK
Corporations mostly issue common stock, which usually comes with voting rights. They also issue preferred stock, which is similar to common stock except that it usually does not carry voting rights but almost always comes with a guaranteed fixed dividend and may be callable, meaning that the company has the option to repurchase the shares at anytime, usually at a premium.

A company’s outstanding shares represent the stock currently held by investors, including restricted shares owned by the company's officers and insiders as well as those held by the public. Shares that have been repurchased by the company are not considered outstanding stock.

What a company is “worth” or its market capitalization represents its stock’s share price multiplied by the number of outstanding shares. This has little to do, though, with the book value of the company, which is based on actual financial performance.

Not all company shares are available for trading, with some restricted shares issued to management, for instance. The total number of shares publicly owned and available for trading is called float and it is calculated by subtracting restricted shares from outstanding shares.

Investors can find the best offer or best bid for a given stock through their broker or market data vendors. The NBBO or national best bid/offer represents the lowest available selling price and the highest available buying price, the difference between the two being the spread or the Market data also display the size of the sell or buy order available at a specific price. The depth of book refers to the full list of all buy or sell orders.

Types of Stocks

LISTED STOCKS are shares that were first floated on an exchange or self-regulated organization (SRO), a marketplace that has the authority to set trading rules and fees, monitor trading and police its members or market participants.

Listed stocks mostly trade on the New York Stock Exchange, the world’s largest exchange. But NYSE stocks can also be traded on other national exchanges, such as the American Stock Exchange, regional exchanges and Nasdaq that all are members of the Intermarket Trading System (ITS) plan. The idea is that investors can always get the best price for the stock they want to buy or sell, regardless of the marketplace that displays the best bid or offer.

ITS is the now-outdated network that links those markets. The plan has rules, the most famous of which is the trade-through, which seeks to deter brokers from executing customer orders at a price than the national best bid/offer or NBBO.

One big short-coming of the trade-through rule is that it does not differentiates between an NBBO that represents an actual order and one that represents an indicative quote, as displayed by specialists on a floor-based auction system. As electronic trading made strides, the SEC recognized this issue as part of the new Regulation NMS provisions.

Unlike the NYSE, NASDAQ is not an exchange although, in the words of the SEC, it looks like one in most respect. Nasdaq is the marketplace ran by FINRA, the SRO formerly known as the National Association of Securities Dealers, but it is expected to become a full-fledged exchange in the coming months.

NASDAQ STOCKS trade like NYSE stocks do in all respects, except that there is no trade-through rule. This distinction will disappear when Nasdaq becomes an exchange or Reg NMS and the abolition of the trade-through rule comes into effect, meaning no later than by the spring of 2006.

As Reg NMS comes into effect, manual, floor-based quotes will not receive any protection, but all electronic quotes—including for Nasdaq stocks—will be subject to the new Order Protection Rule. In other words, orders will have to be executed at the NBBO if the NBBO is represented by an electronic, immediately executable quote. When the Order Protection Rule comes into effect in the spring of 2006, nothing will differentiate trading in listed and Nasdaq stocks.

Regardless of the market-specific rules that may apply to trading in various stocks, all brokers must meet their best-execution obligation, meaning they must execute orders at the best price available.

ADRs [American Depository Receipts] are negotiable certificates issued by a U.S. bank representing a specified number of shares in a foreign stock traded on a U.S. exchange. ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas, and help to reduce administration and duty costs on each transaction that would otherwise be levied.

Large foreign companies, such as Japan’s Sony, can also elect to directly list on a U.S. exchange, in which case they trade just like any other U.S. listing and are not ADRs.

European banks issue European depository receipts and other banks global depository receipts.

EXCHANGE-TRADED FUNDS are securities that track an index and represent a basket of stocks like an index fund, but trade like a stock on an exchange. ETFs provide the diversification of an index fund as well as the ability to sell short, buy on margin and the costs related to owning ETFs are lower than the average mutual fund.

The best known ETFs are the SPDR [Spider] and QQQQ [Cubes], which respectively track the S&P 500 index and the Nasdaq-100 Trust.

OVER-THE-COUNTER BULLETIN BOARD [OTCBB] equities are not listed on an exchange or Nasdaq and include stocks with limited liquidity and market capitalization, foreign equity issues, warrants, units, American Depositary Receipts (ADRs) and Direct Participation Programs (DPPs).

Despite the higher risks, lesser liquidity and greater spreads inherent to these equities, trading in OTCBB securities has gained in popularity, due to the increased transparency provided by electronic markets, such as NASD’s ADF and ArcaEx.

PINK SHEETS stocks are issued by companies that do not meet minimum listing requirements and do not file reports with the SEC. Pink Sheets are a daily publication compiled by the National Quotation Bureau and got their name because they were actually printed on pink paper. Their stock symbol ends in ".PK".

Where do Stocks trade?

Stocks trade on securities exchanges, like the New York Stock Exchange (NYSE) or regional exchanges where orders from buyers and sellers interact; on Nasdaq, the original over-the-counter marketplace with different trading rules; on electronic order-matching venues, the ECNs; or in off-market venues, such as a broker’s block-trading desks or on alternative trading systems (ATSs).

Because there are many ways to trade stocks, there are four markets to trade them: primary, secondary, third and fourth.

  • The PRIMARY MARKET is where a stock is first issued and “listed.” The NYSE has stringent listing rules that apply to mature companies and Nasdaq more flexible ones, which makes the electronic market the ideal place for emerging and high-growth listings.

When a company wants to go public, it retains a brokerage firm to act as underwriter to help prepare the legal, financial and regulatory documents needed to conduct an IPO, including with the “shelf-registration.” The “red herring” is the first draft of a prospectus the company files with the Securities and Exchange Commission.

With the SEC’s approval, the underwriter can prepare and circulate a final prospectus detailing the price and restrictions for the stock to be issued.

A company can also go for a “dual listing” or when a stock is listed on more than one exchange—not to confuse when it is traded on more than one exchange. Many large international companies are dual listed on their home stock exchange as well as a major U.S. exchange.

If a company fails to meet certain financial requirements, the exchange can elect to “delist” its stock. Stocks whose price drops sharply are called “falling knives” and the wisdom is to never try to catch one!

  • The SECONDARY MARKET is where a stock can be bought and sold among investors. It may be on the same exchange where the issuing company conducted its IPO or on any other marketplace, whether it is another exchange or an alternative trading venue.

To ensure that investors always receive the best price for their order, the SEC mandated the creation of the Intermarket Trading System (ITS) linking exchanges. The new Regulation NMS will uphold the “best-price” principle but limit it to firm and accessible orders. It also calls for more efficient ways to access markets, such as private connections.

The most important factors affecting a stock price are the company’s earnings and earnings outlook; for major stocks, such as sector-leader Intel, the company’s mid-quarter earnings outlook update is another potential market-moving event, not only for that company’s stock, but for other companies in the same or a related sector.

But a slew of factors from economic conditions to technical factors can affect a stock price—either way.

Investors must use a broker to buy and sell stocks. It can be an online broker, for those who value low cost and efficiency, or a full-service broker for those who are prepared to pay more for assistance and added services, such as research.

  • The THIRD MARKET describes trading in exchange-listed or Nasdaq-listed issues away from an exchange, directly between institutional investors and brokers-dealers. Also called the “UPSTAIRS” market, it represents the network of brokerage desks that handles large transactions or blocks, usually orders of at least 10,000 shares.

  • The FOURTH MARKET describes the trading of securities directly between institutions on an ATS, with no interaction with the broker. The fourth market has gained in popularity with the support of new technologies that makes it easier for buy-side members to negotiate among themselves.

  • The general concept of best execution applies to stock trading in all MAJOR FINANCIAL MARKETS around the world. Some of the rules differ under different regulators and some markets, such as Euronext, come under different regulatory systems because they operate in several countries.

  • Regulatory convergence is a big issue toward achieving transatlantic trading, with the Securities and Exchange Commission and the Council of European Securities Regulators working to resolve many hurdles, such as unified standards for broker-dealer registration that would allow financial institutions to seamlessly operate in the EU and the United States.
Order Execution

Since the 19th century, U.S. stocks listed on the New York Stock Exchange (NYSE) and regional exchanges have traded under a floor-based auction format where the specialist plays a key role.

The specialist manages the auction process in the specific stock he is responsible for, setting the opening price and taking bids and offers throughout the session. The specialist can execute orders immediately if he can match bids and offers brought to his post by floor brokers or hold the order until it reaches the price the customer is hoping for. Because he is responsible for maintaining orderly markets, the specialist can also buy or sell stocks from his own inventory to lessen volatility.

But technology is rapidly changing that landscape, as the Securities and Exchange Commission passed Regulation NMS that will acknowledge the importance of electronic quotes representing firm orders vs. manual quotes that do not provide guarantee of execution.

The NYSE is now taking an active part in the electronic evolution of markets and is awaiting regulators’ green light to offer a level of auto-execution with an upgraded Direct+ platform. The NYSE is also acquiring its electronic rival, the ArcaEx exchange, which may, ultimately, turn the venerable institution at the corner of Wall and Broad into a virtual marketplace.

Nasdaq ushered the electronic trading revolution in 1971, with his modest debut as the National Association of Securities Dealers’ facility where market-makers could post their prices for over-the-counter securities. Over the years, Nasdaq evolved into an increasingly sophisticated marketplace where market-makers could instantly match orders or negotiate them via electronic messaging.

Nasdaq is broadening the scope of its services via strategic acquisitions of the Brut and Inet ECNs. It is expected to soon become a full-fledge exchange, due to market structure changes introduced by Regulation NMS.

The popularity of straightforward order-matching owes a lot to Nasdaq too, in a way. A collusion scandal among its market-makers in the 1990s spurred the SEC to issue regulations that led to the rise of the ECNs, such as Island and Archipelago, as alternative execution venues that match limit orders.

Stock Indices

Securities exchanges and the Nasdaq market calculate the aggregate performance of a selected number of stocks in indices. Although the indices do not trade, they are important gauges of market performance and are broadly used for technical analysis or portfolio tracking. They also support popular exchange-traded funds (ETFs), securities that track all the components of the index but trade like a single stock.

The most prestigious index is the Dow Jones Industrial Average, the price-weighted average of 30 significant stocks traded on the NYSE and Nasdaq. The DJIA was invented by Charles Dow in May 1896 but it was even narrower then, with only 12 components, only one—General Electric—today is still part of the world’s oldest index. But even GE was dropped out of the index in 1898 but came back in 1907 when Tennessee Coal & Iron was bought by J.P. Morgan-run U.S. Steel .

Much younger is the Nasdaq 100 Index, launched in 1985, which includes 100 of the largest non-financial domestic companies listed on the Nasdaq National Market tier of the Nasdaq stock market. Each security in the index is represented according to the proportion of its market capitalization in relation to the total market value of the index. The QQQQ is the ticker symbol for the Nasdaq-100 Trust, the ETF that tracks the Nasdaq-100 and is one of the world’s most liquid securities.

The S&P 500, designed by Standard and Poor’s, is one of the best benchmarks for large-cap stocks. The performance of the S&P 500 is considered one of the best overall indicators of market performance. A mutual fund manager’s goal is to beat it or “generate alpha.”

Types of Traders

Trading stocks has changed a lot over the past decade, due to the impact of trading technologies, including access to real-time data. Today, there is a slew of trading strategies—a number of which that are real-time data-driven—that have led to some arbitrary classification of different groups of traders, including:

  • MOMENTUM TRADERS trade stocks that move in one clear direction in heavy volume. They get in and out of their position very quickly, watching to exit before “saturation” or when the volume between buy and sell orders is close to equilibrium, meaning that the momentum is on the wane.

Although momentum trading is data-driven, traders need to identify the cause of the mono-directional move in order to better evaluate whether it has “legs” or if saturation is near.

  • “SCALPERS” trade stocks extremely frequently throughout the day, trying to pocket small—but relatively risk-free—profits from the bid-ask spread. They are a faster, more sophisticated version of the original day traders who used Nasdaq’s Small Order Execution System (SOES) to beat the market-makers in the 1990s.

Unlike the momentum trader, the scalper looks for stocks with relatively stable price action. Because of their active role on both sides of the market, scalpers have been called the NEW MARKET-MAKERS, as they provide liquidity on either side of the market throughout the day, although not at the same time. They are not bound by market-makers’ obligation to maintain two-sided markets.

  • TECHNICAL TRADERS, the “back to the future” traders, are driven by charts and look for signs of convergence or divergence—or the deviation from a benchmark or reference point—hoping that stock price patterns that have emerged in the past will be repeated.

For instance, the Moving Average Convergence/Divergence (MACD) charts are popular indicators because they clearly show how much a stock price is departing from its performance of the past two weeks or year. MACD are oscillating indicators that signal an overbought or oversold situation, compared to past performance but not in absolute terms.

While there are many methods of technical analysis, including the Fibonacci sequence and Elliott Wave theory, none are full-proof. Technical traders often watch several methods at the same time, looking for reinforcement of a possible scenario.

Much maligned by some, technical analysis is nevertheless powerful enough to determine where many “stops” are—meaning the price at which a significant number of market participants feel it is worth buying or selling a stock. Therefore, the market cannot ignore where the buy-stop and sell-stop limit orders sit.

  • ALGORITHMIC TRADERS are in vogue for their ability to fully leverage the latest technology to maximize their strategy. Algorithmic trading broadly refers to a computer program that automatically generates orders when some pre-set parameters are met, with the intent to perform better than a specific benchmark.
  • Algorithmic traders need real-time market data, super-fast broadband access to markets and a truly “smart” smart-router to achieve those goals.

They build their own trading model adapted to their strategies or look for a third-party provider to build it for them. The software picks up the market signal provided by real-time market data and spits out buy or sell orders, according to the pre-programmed algorithm. Algorithmic trading is a great fit for scalpers, momentum traders or chart-minded traders: whenever the conditions to execute a particular strategy are met, the system will trade in less than a blink.

All active traders need a technology-savvy broker to support their strategies, preferably one with low commissions because fees can quickly pile up and wipe out gains for those who trade all day.

  • FUNDAMENTAL TRADERS are the buy-and-hold type and study fundamentals to try to evaluate a stock, based on its intrinsic value. They are often portfolio managers at a mutual or pension fund and closely follow all news related to the stock, such as earnings, as well as major industry trends or the overall economic outlook.
  • SWING TRADERS focus on back-and-forth trading action within a band: unlike momentum traders, they look for stocks that lack volatility, trying to buy in the dips and sell in the spikes within a price range. They don’t get in and out of the market several times a day and prefer stocks that fluctuate within a band, limiting the potential for losses while getting out close to the top of the band.

Investors most often follow the price-earnings (P/E) ratio or the valuation of a company’s share price compared to its per-share earnings. It is usually based on the last four quarters—the trailing P/E. Analysts increasingly focus on expected earnings or forward P/E. The P/E is often referred to as the “multiple” and gives an idea of how pricey or comparatively affordable the stock is. This is mostly useful when comparing companies in the same sector.

Regardless of the trading strategy used, investors should be cautious about some usual market pitfalls, usually described in a colorful Wall Street jargon. For instance, beware of “Mad Hatters” or management team whose ability is questionable. The expression refers to “Alice’s Adventures in Wonderland” when the Mad Hatter constantly quizzes Alice with nonsensical and unanswerable questions.

Also, the “Greater Fool” theory suggests it is possible to make profits by buying stocks at any price on the hope there will always be someone else—a “bigger fool”—to buy it. Since the time of the “tulip” craze in the Netherlands, this has been the driver of dangerous bubbles.

Stock Order Types

To execute various strategies, traders can use various order types. Among the most popular are:

BASKET A batch of individual orders submitted simultaneously as a package, usually late in the trading day—a very popular arbitrage strategy
BRACKET A type of order that limits the downside risk while locking in possible profits when exiting a position by simultaneously entering a stop order and a limit order
CONDITIONAL An order that will be submitted or canceled when some preset criteria are met; examples include all-or-none, meaning the entire order must be executed at one go; fill-or-kill, meaning the entire order must executed within a specific timeframe; immediate-or-cancel, meaning any part of the order that is not immediately executed is canceled
DISCRETIONARY A limit order with a price range around its limit
GOOD-TILL good-till-date, good-till-time, good-till-canceled remain valid orders until a specific timeframe or customer’s decision to cancel
LIMIT An order to buy or sell shares at a certain price; time-specific limit orders can be on limit-on-open and limit-on-close
MARKET An order to buy at the bid or sell at the best price available at the time; market-on-open and market-on-close are market orders at the start and the end of the trading day; with a market-to-limit order, part of the order is not executed at the prevailing market price at a given moment, the remaining part becomes a limit order set at the level where the market order was filled
PEGGED A pegged order tracks the inside quote, meaning the spread between the best bid and the best offer
STOP An order to be executed at the best market price available when a certain price level has been reached; a stop-limit order is to be executed at a specific price, once the stop has been reached; stop-loss orders trigger the selling of a stock when a share price falls below a specific level; trailing stops set a new stop price in response to the stock’s fluctuation
Short Selling

Investors who buy a stock believing its price will rise are said to be “long” the stock. Those who believe the stock price will go down can “short” the stock by selling the stock, although they don’t own it, but promise they will deliver it at some point. Short selling can also be to hedge the risk of a long position.

Customers borrow the stock they want to short from their brokers, the margin account of other clients at the same brokerage firm or an outside lender. Because it is a loan, some brokers pay the short-seller an interest rate and subtract the cost associated with borrowing shares.

If the short-seller does not borrow the securities in time to make delivery within the three-day settlement period, it is a “naked” short sale.

The SEC has issued a new Regulation SHO to update short sale regulation. This includes the obligation to “locate” and “close-out” requirements to address problems associated with failures to deliver, including potentially abusive "naked" short selling. Reg SHO also requires exchanges and the FINRA to publish every day the list of “threshold” securities that cannot be borrowed because they are not easily available.

Margin

Whenever an investor needs to borrow money from his broker to buy a stock, he must open a margin account with his broker, sign a related agreement and abide by the margin requirements that apply. Some brokers extend more lenient lending conditions than others and lending terms may also vary from one client to the other but brokers must always operate within the parameters of margin requirements set by regulators.

Not all securities can be bought on margin, just as not all securities can be shorted. Buying on margin is a edge sword that can translate into bigger gains or bigger losses. In particular in volatile markets, investors who borrowed from their brokers may need to provide additional cash if the price of a stock drops too much for those who bought on margin or rallies too much for those who shorted a stock. It’s a margin call.

In such cases, brokers are also allowed to liquidate a position, even without informing the investor. Real-time position monitoring is a crucial tool when buying on margin or shorting a stock.

MARGIN RULES
The Federal Reserve Board and self-regulatory organizations (SROs), such as the New York Stock Exchange and FINRA, have clear rules regarding margin trading.

In the United States, the Fed’s Regulation T allows investors to borrow up to 50 percent of the price of the securities to be purchased on margin for the “INITIAL MARGIN.”

Once investors have started buying a stock on margin, the NYSE and FINRA require them to keep a minimum amount of equity in the margin account. These rules require investors to have at least 25 percent of the total market value of the securities they own in their margin account—meaning that their leveraging power is four times the balance in the account. This is the “MAINTENANCE REQUIREMENT.” For market participants identified as day traders, the maintenance requirement is $25,000.

When the balance in the margin account falls below the maintenance requirement, the broker can issue a margin call requiring the investor to send more cash or can liquidate the position.

In the United States and Canada, the margin requirements are “rule-based,” meaning regulators set specific limits. In many overseas markets, margin requirements are “risk-based” according to a risk evaluation model similar to what applies to U.S. futures.

Clearing & Settlement

Billions of stock shares change hands every day between people who usually don’t know each other and need know that, by the end of the day, the sellers will get paid and the buyer will get his securities.

In the United States, this process is handled by the Depository Trust & Clearing Corporation (DTCC), the world’s largest financial post-trade organization whose subsidiaries support post-trade processing and money settlement for broker-to-broker trades and institutional trades.

Broker-to-broker trades are processed by DTCC’s National Securities Clearing Corporation (NSCC) subsidiary, which handles post-trade processing for equity, municipal and corporate bond transactions. DTCC also handles for U.S. Government and mortgage-backed securities, money market instruments, mutual funds, insurance products and over-the-counter derivatives.

Institutional trades from mutual funds, pension funds, hedge funds, banks or insurance companies are handled by DTCC’s Depository Trust Company (DTC) subsidiary. Omgeo, a joint venture between DTC and Thomson Financial, provides the communications hub for the parties to an institutional trade to exchange information.

NSCC provides a series of clearing and settlement services, including: Automated Customer Account Transfer Service (ACATS) for the transfer of assets in a customer account from one brokerage firm and/or bank to another; Continuous Net Settlement System (CNS) for automated book-entry accounting system that centralizes transactions’ settlement; and Correspondent Clearing Service, a trade-reporting service that processes equity and corporate bond transactions executed by NSCC members on behalf of other participants or correspondents.

Another important service is the Stock Borrow Program that allows participants to lend NSCC available stocks and fixed income securities from their account at DTC to cover temporary shortfalls in the CNS. NSCC, as the leading U.S. provider of centralized clearance and settlement services to brokers and other financial institutions, provides automated services, including the Dividend Settlement Service (DSS), a centralized system that collects dividends and interest owed to participants by other financial institutions.

DTC provides custody and asset servicing for more than 2 million U.S. and foreign securities as the national clearinghouse for the settlement of trades in corporate and municipal bonds.

Equity FAQs
What are Stocks?

Equity securities, or stocks, represent an ownership interest in a corporation. Interactive Brokers offers trading of exchange-listed stocks, such as those traded on the New York Stock Exchange and the American Stock Exchange, and certain over-the-counter stocks, specifically, National Association of Securities Dealers ("Nasdaq") National Market Securities and SmallCap Securities. These stocks are deemed to be "marginable securities" by the United States Federal Reserve Board. Interactive Brokers Customers may trade stocks in one of three accounts: (I) a "Stock Cash Account"; (II) a "Stock Margin Account; or (III) a combined "Stock and Options Margin Account". In a Cash Account, the Customer pays the full purchase price of the stock. In either of the two Margin Accounts, the Customer pays a portion of the purchase price (called "margin") and borrows the balance of the purchase price from Interactive Brokers. The loan from Interactive Brokers is secured by the securities purchased by the Customer. To establish a Margin Account, Customer must agree: (a) to repay to Interactive Brokers the funds it borrows, with interest; and (b) that Interactive Brokers may lend, pledge or hypothecate Customer's stock to facilitate Customer's margin transactions. Customer must also acknowledge that there is a higher potential for loss when purchasing stock on margin versus purchasing stock for cash.

Generally, investors purchase shares of stock if they believe the value of a company's stock will increase. Investors may purchase stocks either by paying the full cash price or by using margin. See How Margin for Securities Trading Works. Investors sell shares of stock to either liquidate a long position or to be short the stock. An investor may sell stock short if he anticipates a decline in the value of the stock. Short sale transactions involve the sale of stock that the investor does not own. Therefore, prior to effecting an order to sell a stock short for a customer, Interactive Brokers is required to determine that it can borrow an equal amount of shares on behalf of Customer. For this reason, short sale transactions may take place only in a Margin Account since the customer must agree to allow Interactive Brokers to borrow stock for Customer and pledge and hypothecate Customer's assets to facilitate the short sale transaction. If the stock Customer sold short rises in value and Customer is forced to buy the stock at the higher, current market price to cover the short sale the Customer may incur a loss on the trade. The potential loss on a short sale is unlimited since there is no limit to how high a stock can rise in price. Conversely, if the stock that was sold declines in price below the price at which the investor sold it, the investor can realize a profit by purchasing the stock at its current, lower price. In this case, Interactive Brokers would return the borrowed shares to the lender. Short sellers may incur charges for the shares borrowed and are subject to unlimited loss.
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What are Equity Options?

Equity options contracts represent the right, not the obligation, to assume a position in the underlying equity security at a specific price any time before the option expires. The equity options Interactive Brokers makes available for trading are issued by The Options Clearing Corporation (OCC) and are traded on United States exchanges. Customers must, prior to placing their first equity options order, acknowledge to Interactive Brokers that they have received and understand the OCC document "Characteristics and Risks of Standardized Options".

Equity options are expressed by their "symbol" followed by "expiration month" and "strike price", for example: "XYZ Oct1999 50 calls". They have standardized terms, for example, most option contracts represent 100 shares (the "contract multiplier") of the underlying stock and are issued 9 months in advance of their "expiration date" (the Saturday following the "last trading day" (usually the third Friday) of the expiration month). All options contracts covering XYZ stock are referred to as an "options class". The dollar value of a call or put equity options contract is the unit price of the option (called the "premium") x the contract multiplier (the number of underlying shares per option contract).

U.S. exchange-traded equity options are "physical delivery" options and are exercised "American Style", which means that they may be exercised for delivery of the underlying shares at any time until the expiration date. To participate in a voluntary corporate action, submit an Inquiry/Problem ticket via Account Management. To do this, go to Account Management and from the menu select Account Services, then select Corporate Actions. Click here for more information. Prior to expiration, OCC will automatically exercise any long call or put option positions that are "in-the-money" by $0.01 or more. Exchanges impose position and exercise limits on the number of options contracts per side (call and put) and Customers must agree that they will comply with applicable law and not exceed such limits.

Equity options are typically used by investors who anticipate either an increase or decrease in the price of a certain stock to have the right, until the expiration of the option contract, to close out the option or exercise it and buy or sell the underlying stock at a predetermined price. In addition, investors may use options to hedge their long or short stock positions.

The buyer of a call or put option (known as the "holder") must pay the full premium of the option. The seller (known as the "writer") of a put or call option receives a premium upon selling the option and is required to meet margin requirements. See "Interactive Brokers Margin Specifications for Equity Options". Interactive Brokers Customers who buy a call or put option must have sufficient equity in their account to pay for the full purchase price of the option. Interactive Brokers Customers who sell (or "write") equity options, must have sufficient equity in their account to meet Interactive Brokers margin requirements.

There are a number of financial risks associated with trading options. It is beyond the scope of this section, or this website, to identify and fully discuss all of the risks associated with trading options. Interactive Brokers does not provide investment, tax or other advice. Customers must consult with their professional advisors regarding investment strategies, tax implications and other implications, such as the risks, of trading options. Customers are also encouraged to view the websites of the various exchanges and the OCC, the OCC document "Characteristics and Risks of Standardized Options" and published material to obtain a full understanding of trading options and the risks involved. For an expanded discussion, please visit the Interactive Brokers website page "Aspects and Risks of Trading Equity Options".
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Where can I receive additional information on options?

On July 3, 2000, The Options Clearing Corporation began operating a call center to serve individual investors and retail securities brokers. The resource will address the following questions and issues related to OCC cleared options products:

  • Options Industry Council information regarding seminars, video and educational materials;
  • Basic options-related questions such as definition of terms and product information;
  • Responses to strategic and operational questions including specific trade positions and strategies.

The call center can be reached by dialing 1-800-OPTIONS. The hours of operation are Monday through Thursday from 8 a.m. to 5 p.m. (CST) and Friday from 8 a.m. to 4 p.m. (CST). Hours for the monthly expiration Friday will be extended to 5 p.m. (CST).

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Aspects and Risks of Trading Equity Options

Equity options contracts represent the right, not the obligation, to assume a position in the underlying equity security at a specific price any time before the option expires. All equity options contracts traded on a United States exchange are issued by The Options Clearing Corporation (OCC). Interactive Brokers offers trading in OCC issued equity options. Investors who want to trade equity options must, prior to placing their first equity options order, acknowledge to their broker that they have received and understand the OCC document "Characteristics and Risks of Standardized Options".

Equity options available for trading through Interactive Brokers have standardized terms, for example, most option contracts represent 100 shares (the "contract multiplier") of the underlying stock. Equity options are expressed by their "symbol" followed by "expiration month" and "strike price", for example: "XYZ Oct 1999 50 calls". All options contracts covering XYZ stock are referred to as an "options class". The dollar value of a call or put equity options contract is measured by the price of the option (called the "premium") x the contract multiplier (the number of underlying shares per equity options contract).

Expiration

Equity options contracts are usually issued 9 months in advance of their "expiration date". The expiration date for equity options contracts is the Saturday following the "last trading day" for the option contract. The last trading day is usually the third Friday of the expiration month, except if the third Friday of the expiration month is a holiday, then the last trading day is the preceding Thursday.

Exercise

U.S. exchange-traded equity options are "physical delivery" options. That is, the owner of a call option has the right, upon "exercise" prior to the time for expiration, to receive physical delivery of the underlying stock in return for payment of the "exercise price" and the owner of a put option has the right, upon exercise, to make delivery of the underlying stock in return for receipt of the exercise price. These options are exercised "American Style", which means that they may be exercised at any time between the date of purchase and the expiration date. "European Style" options may be exercised only on the expiration date. The expiration date is the last day that an option may be exercised.

If, at expiration, a Customer (1) desires to exercise a long option position that is in-the-money by less than $0.01, or (2) does not desire to exercise a long option position that is in-the-money by $0.01 or more, the Customer must provide Interactive Brokers with a "contrary exercise notice" instruction using the Option Exercise window (accessible from the TWS View menu) prior to 4:30 p.m. U.S. Eastern Standard Time on the last trading day (usually the third Friday of the expiration month, unless such Friday is a holiday, then the preceding Thursday) prior to the option's expiration date (Saturday). In the absence of "contrary exercise notice" instructions received from Customer prior to 4:30 p.m. U.S. Eastern Standard Time on the last trading day, at expiration Customer's long call or put options contracts which are "in-the-money" by $0.01 or more will be automatically exercised by OCC. For instructions on using the Option Exercise window, see the TWS User's Guide.

The implication of the expiration date to a buyer (holder) of call equity options contracts who does not close out an options position prior to expiration is that positions that are in-the-money by $0.01 or more will be automatically exercised by OCC and the holder will be long an equivalent number of shares. The implication of the expiration date to a seller (writer) of call equity options contracts who does not close out an options position prior to expiration is that the writer may be assigned, thereby obligating the call writer to deliver the number of shares represented by the options contracts at the exercise price.

The implication of the expiration date to a buyer (holder) of put equity options contracts who does not close out an options position prior to expiration is that positions that are in-the-money by $0.01 or more will be automatically exercised by OCC and the holder will be short an equivalent number of shares. The implication of the expiration date to a seller (writer) of put equity options contracts who does not close out an options position prior to expiration is that the put writer may be assigned, thereby obligating the put writer to purchase the number of shares represented by the options contracts at the exercise price.

Example 1

Assume XYZ Oct 50 calls have a premium of $4.00. A buyer of 1 XYZ Oct call option contract would pay $400 ($4 x 100), and obtain the right, but not the obligation, to close out the contract by:

  1. selling 1 XYZ Oct 50 options contract prior to the contract's close of trading on the last trading day (the third Friday) of the contract expiration month (in this example, October);
  2. exercising the 1 XYZ Oct 50 options contract prior to its expiration;

Note A: In the absence of written "contrary exercise notice" instructions received from Customer prior to 4:30 p.m. U.S. Eastern Time on the last trading day, at expiration Customer's long call or put options contracts which are "in-the-money" by $0.01 or more will be automatically exercised by OCC.

Note B: In the above example, if the call had not been closed out through either a sale or exercise, or if the call was not automatically exercised by OCC because it was out-of-the-money, or in-the-money, by less than $0.01, the call will expire and the buyer of the call would lose the $400 paid for the contract.

Example 2

Assume XYZ Oct 50 calls have a premium of $4.00. A seller (known as the "writer") of 1 XYZ Oct call option contract would receive a premium of $400 ($4 x 100), and may close out the contract by buying 1 XYZ Oct 50 call option contract prior to expiration. However, prior to closing out the contract, the call writer is obligated to deliver the underlying shares if he is assigned.

Note: In the above example, if at expiration the call is in-the-money by $0.01 or more, OCC will automatically exercise the call, obligating the call writer to deliver the number of shares represented by the options contracts. If the call was not automatically exercised by OCC because it was out-of-the-money, or in-the-money, by less than $0.01, the call will expire and the call writer will have profited by the $400 received when the call was written.

Uses of Equity Options

Interactive Brokers does not provide investment, tax, or other advice. Interactive Brokers Customers make their own trading decisions and must consult with their independent advisors, if necessary. Investors who anticipate either an increase or decrease in the price of a certain stock, may buy equity options contracts to have the right, until the expiration of the option contract, to buy or sell that stock at a predetermined price. A call option provides an investor with the right, but not the obligation, to buy shares of the underlying equity security at a fixed price, known as the "strike price". A put option provides an investor with the right, but not the obligation, to sell shares of the underlying equity security at the strike price. Strike prices for equity options are generally set at 5 point intervals and may be added for trading as the price of the underlying stock moves toward either end of the range of listed strike prices for that option. In addition, investors may use options to help hedge their long or short stock positions.

The buyer of an option is called the "holder". The seller of an option is called the "writer". An option is "at-the-money" when its strike price equals the market price of the underlying stock. A call option is "in-the-money" when its strike price is less than the market price of the underlying stock and "out-of-the-money" when its strike price exceeds the price of the underlying stock. A put option is "in-the-money" when its strike price exceeds the market price of the underlying stock and "out-of-the-money" when its strike price is less than the price of the underlying stock.

If Customer has sold (or "written") a call option, Customer will be obligated to sell the underlying stock at the exercise price of the option if Customer is "assigned". An assignment occurs when the call option is exercised, either by the holder or automatically at expiration if the option is in-the-money by $0.01 or more. Call options are generally exercised when they are in-the-money. If assigned pursuant to an exercise, the writer of a put option will be obligated to buy the underlying stock at the exercise price of the option, while the writer of a call option will be obligated to deliver the underlying stock at the exercise price of the option. Customers who have sold ("written") options can anticipate being "assigned" at anytime, especially if the option is "in-the-money" Customers must be aware that OCC will automatically exercise any option that is in-the-money by $0.01 or more at expiration.

In contrast to the buyer (holder) of a long option position, who must pay the full purchase price of the option, an option writer is subject to margin requirements. An uncovered ("naked") call writer is one who does not have an equivalent long position in the underlying stock represented by the option contract. An uncovered put writer is one who does not have a corresponding short position in the underlying security.

Margin Requirements

Interactive Brokers requires option writers to meet initial and maintenance margin requirements in their Stock & Options Margin Account as set forth on the "Interactive Brokers Margin Specifications for Equity Options" page. IB Customers who buy a call or put option must have sufficient equity in their account to pay for the full purchase price of the option. IB Customers who sell (or "write") equity options, must have sufficient equity in their account to meet the initial margin requirements of the resulting position.

Miscellaneous

Exchanges impose position limits on the number of options contracts per side (call and put) that a person may hold. Interactive Brokers Customers agree in the Customer Agreement not to exceed the position limits imposed by applicable law. Customers will incur a commission for opening and closing transactions, as well as for exercises and assignments. Interactive Brokers does not provide investment, tax or other advice. Customers must consult with their professional advisors regarding investment strategies and tax and other implications of trading options.

Risks

The following highlights certain of the risks associated with options trading, but does not cover all of the risks, nor does it discuss such risks in detail. Customers are encouraged to consult with their investment advisors, the websites of the various exchanges, the OCC document "Characteristics and Risks of Standardized Options" and published material to gain a fuller and better understanding of both trading options and the risks involved. Options involve risk and are not suitable for all investors. For information on the uses and risks of options, you can obtain a copy of the Options Clearing Corporation risk disclosure document titled Characteristics and Risks of Standardized Options from Mr. John Seeberg, Interactive Brokers LLC, 1 Pickwick Plaza, Greenwich, Connecticut 06830 or by calling (203) 618-5800.

Identification of all the general risks which affect options trading, and a discussion of them, is beyond the scope of this section but they include: the trading of the underlying stocks (e.g. trading halts), economic factors (e.g., news releases), supply and demand, volatility, liquidity, the quality of the markets, electronic systems and regulatory requirements.

One risk factor that Interactive Brokers Customers face is the unavailability, for any reason, of the IB System which, in part, relies on facilities of third parties. For this reason, IB Customers must maintain alternative arrangements for the execution of their orders, or the transmission of their exercise instructions since there will be periods of time that the IB System is unavailable, and IB will not be liable to Customer since it does not warrant the performance of its system at all times.

While all of the risks specific to certain option holders and writers cannot be identified, nor discussed in detail, they include:

- Unlike one who buys stock, in order to profit, the buyer of a call or put option must be correct as to the anticipated direction of the price of the stock and timing prior to the expiration of the option. As a result, option holders risk losing all or a portion of their investment in the option if:

  • the underlying stock does not move as anticipated; as the option becomes more out-of-the-money and the time to expiration shortens;
  • courts or regulators impose exercise restrictions, or halts of trading in the underlying stocks, in which case, holders may lose all or a portion of their investment.

Option Writers - The seller (writer) of an American Style option may be assigned at any time. In fact, an option writer may be assigned (obligating the call writer to deliver stock, or the put writer to buy stock) and not learn of the assignment until one or more days later. If, prior to receiving notice of the assignment, the writer enters into a closing transaction (by purchasing an equivalent number of calls or puts, as the case may be), the writer will be obligated to buy or deliver the underlying stock and the closing transaction will be treated as an opening transaction. The amount of loss depends on whether the option writer is "covered" or "uncovered".

Covered call writers give up the opportunity to benefit from an increase in the price of the underlying stock above the strike price, and are at risk for a loss resulting from a decrease in the price of the underlying stock. The decrease in the price of the underlying stock may be wholly or partially offset by the premium the writer received when it sold the call.

Uncovered call writers are exposed to potentially unlimited risk since there is no limit to which the price of the stock they may be obligated to deliver can rise. These losses may be compounded by the margin requirements the uncovered call writer is obligated to meet. Accordingly, uncovered call writing is only suitable for the knowledgeable investor who understands the risks, has the financial capacity and willingness to incur potentially substantial losses, and has sufficient liquid assets to meet applicable margin requirements.

Uncovered put writers bear the risk of loss if the underlying stock declines below the option's strike price and their potential loss is the difference between the exercise price and zero. The put writer is exposed to the additional risk of meeting the margin obligation to maintain the position.

Uncovered option writers can enter into a spread transaction (by purchasing other options on the same underlying stock) or by hedging their position with other types of instruments. The risks attendant to such positions are discussed below.

While uncovered option writers use leverage to help control an equivalent position as an investor for the underlying stock, and thereby increase the potential for greater profit, at the same time they are exposed to greater risk and the potential for greater loss than those who carry positions in underlying stock.

Option writers are not only exposed to the risk of being assigned, and thereby obligated to perform, they may not receive immediate notice of an assignment, enter into a closing transaction, and later learn of the assignment. This will obligate them to perform and transfer their closing position into an open position. Events such as tender offers and exchange offers further complicate, affect the ability to perform, and may increase the cost and risk of loss to, option writers.

Option writers may be assigned pursuant to improper exercise notices- for example, a holder may submit an exercise notice after the time for doing so and OCC will be obligated to assign the notice even though it later turns out the exercise was improper.

If trading or other conditions (for example, electronic systems communications failure) prevent an option writer from closing out a position, the option writer is exposed to its obligations until assignment or expiration.

Option traders who engage in spread or straddle transactions are exposed to the complexity of the transaction itself; and the risk that one side of the spread or straddle transaction becomes assigned, thereby exposing the writer to the obligations of performance and reducing the intended hedge such combination transaction was intended to create. Other risks include not being able to simultaneously enter into the other side of the spread or straddle transaction, thereby altering the intended effect, or profitability of the transaction; the possibility of loss for both sides of the transaction; and the increased transaction costs. In a short straddle transaction, where both a call and put option are written with the same exercise price, there is the potential for unlimited loss. Please note that multi-leg strategies incur multiple commission charges.

Uncovered Option Writers

The following "Special Statement for Uncovered Option Writers" highlights risks for uncovered option writers:

There are special risks associated with uncovered option writing which expose the investor to potentially significant loss. Therefore, this type of strategy may not be suitable for all customers approved for options transactions.

  1. The potential loss of uncovered call writing is unlimited. The writer of an uncovered call is in an extremely risky position, and may incur large losses if the value of the underlying instrument increases above the exercise price.

  2. As with writing uncovered calls, the risk of writing uncovered put options is substantial. The writer of an uncovered put option bears a risk of loss if the value of the underlying instrument declines below the exercise price. Such loss could be substantial if there is a significant decline in the value of the underlying instrument.

  3. Uncovered option writing is thus suitable only for the knowledgeable investor who understands the risks, has the financial capacity and willingness to incur potentially substantial losses, and has sufficient liquid assets to meet applicable margin requirements. In this regard, if the value of the underlying instrument moves against an uncovered writer's options position, the investor's broker may request significant additional margin payments. If an investor does not make such margin payments, the broker may liquidate stock or options positions in the investor's account, with little or no prior notice in accordance with the investor's margin agreement.

  4. For combination writing, where the investor writes both a put and a call on the same underlying instrument, the potential risk is unlimited.

  5. If a secondary market in options were to become unavailable, investors could not engage in closing transactions, and an option writer would remain obligated until expiration or assignment.

  6. The writer of an American-style option is subject to being assigned an exercise at any time after he has written the option until the option expires. By contrast, the writer of a European-style option is subject to exercise assignment only during the exercise period.

NOTE: It is expected that you will read the booklet entitled CHARACTERISTICS AND RISKS OF STANDARDIZED OPTIONS available from your broker. In particular your attention is directed to the chapter entitled Risks of Buying and Writing Options. This statement is not intended to enumerate all of the risks entailed in writing uncovered options.

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How Margin for Securities Trading Works

Stock may be purchased in one of two ways. One way is to pay the purchase price in full (called a "cash transaction"). Another way is to buy the stock on margin, that is, by paying a portion of the purchase price (called "initial margin") and borrowing the balance from a broker (called a "margin transaction"). Margin transactions effected in an Interactive Brokers Margin Account are subject to United States Federal Reserve Board Regulation T and New York Stock Exchange ("NYSE") initial and maintenance margin requirements. In addition, Interactive Brokers may at any time and without notice to Customer: (a) impose higher initial or maintenance margin requirements than those imposed by the NYSE; (b) determine that a particular stock may not be purchased on margin; or (c) automatically liquidate a Customer's margined position.

Interactive Brokers will generally require initial margin for a purchase of stock on margin to be equal in amount to the greater of: (a) that required by the U.S. Federal Reserve Board, currently 50%, or (b) that required by the NYSE, currently $2,000, unless the full purchase price of the stock is less than $2,000, then the full purchase price. However, Interactive Brokers may require a higher amount of initial margin for any particular margin transaction.

The following section: (A) defines certain terms as they are applied under Interactive Brokers' Rules for Trading Securities on Margin; (B) sets forth Interactive Brokers' Rules for Trading Securities on Margin; and (C) provides several examples to illustrate trading on margin in an Interactive Brokers securities margin account.

A. Definitions

Equity equals the current market value of all (a) available funds plus (b) long stock and options positions carried in an Interactive Brokers securities Cash Account or Margin Account, less (c) short stock and options positions carried in an IB securities Margin Account, (d) the amount borrowed, (e) the interest incurred on the amount borrowed and (f) commissions and fees.

Initial margin represents the initial payment required for a margin transaction. It also represents the initial equity Customer has in a particular stock since the balance of the payment for such stock is made with funds Customer borrows from, and owes (with interest), to Interactive Brokers.

Liquidation amount is that amount of Customer's position that the Interactive Brokers system, pursuant to a proprietary algorithm, will automatically liquidate at the point at which the equity in Customer's account falls below Interactive Brokers' minimum maintenance margin requirement. The Interactive Brokers system is designed to liquidate Customer's most recent transactions in 100 share and 1-option contract increments, or such amount of shares or option contracts held by customer that, following liquidation, will provide the account with equity in excess of Interactive Brokers' minimum maintenance margin requirement at the time of liquidation.

Minimum maintenance margin is the amount of available funds an Interactive Brokers Customer is required to have in an Interactive Brokers securities margin account to maintain, and prevent an automatic liquidation of, a margined securities position. Interactive Brokers' minimum maintenance margin requirement will be based on the New York Stock Exchange's minimum maintenance margin requirement, as follows:

For stock purchased on margin - currently 30% of the current market value of the long securities position. Interactive Brokers requires $2,000 minimum account equity for all margin transactions.

For stock sold short - 30% for underlying stock priced $17.00 per share or more; or $5.00 per share for stock priced between $5.00 and $16 7/8 per share; or, for stock priced less than $5.00 per share, the greater of 100% or $2.50 per share. Interactive Brokers requires $2,000 minimum account equity for all margin transactions.

However, the amount of minimum maintenance margin required for a particular margin transaction may, at any time and without notice to Customer, be higher. This means that if Interactive Brokers decides to increase the minimum maintenance margin requirement for a particular stock, or in general, and Customer does not have sufficient available funds in an Interactive Brokers securities account, Interactive Brokers may automatically liquidate all, or a portion of, any Customer position(s) sufficient in amount to meet Interactive Brokers' minimum maintenance margin requirement.

B. Interactive Brokers' Rules for Trading Securities on Margin

Customers must acknowledge that Interactive Brokers':

  1. System is designed to automatically liquidate Customer's most recent transactions in 100 share and 1-option contract increments, or such lesser amount of shares or option contracts held by Customer, for a margined securities position if the Customer does not have enough equity in an Interactive Brokers securities account to satisfy Interactive Brokers' minimum maintenance margin requirement;

  2. Minimum maintenance margin requirements are subject to change at any time without notice to customer;

  3. Interactive Brokers' policy is to not issue intra-day margin calls to Customers; and,

  4. Customers must monitor their securities accounts to ensure they have sufficient available funds to, at all times, satisfy Interactive Brokers' minimum maintenance margin requirements.

Customers must also understand that although the use of margin enables you to leverage an investment - since you put up only a portion of the purchase price and borrow the remainder, thereby increasing your purchasing power - it also increases the potential for higher losses because you are liable for both the full purchase price plus interest charges on the amount you borrow. In addition, you may be forced to liquidate your margined position prior to the time you want to in order to meet maintenance margin requirements. Keep in mind that Customer positions maintained in an Interactive Brokers securities margin account are subject to automatic liquidation if the market value of a margined position decreases in value below Interactive Brokers' minimum margin maintenance requirement.

C. Examples of Trading Securities in an Interactive Brokers Margin Account

The following examples demonstrate the use of margin in an Interactive Brokers securities margin account. The following examples are for illustration purposes only and are not meant to encompass a wide variety of situations. (Note: for simplicity, the examples ignore commissions and fees and the amount of daily interest incurred on the borrowed amount, each of which is deducted from the equity in Customer s account):

  1. Customer buys $100,000 worth of stock. Interactive Brokers initial margin requirement is 50%. If Customer has $50,000 in available funds in its Interactive Brokers securities Margin Account, Interactive Brokers will deduct such amount from Customer s account as initial margin toward the purchase of the securities and provide Customer with an interest-bearing margin loan in the amount of $50,000. As a result, Customer's equity in the margin account is $50,000 (less commissions), and Customer has received a margin loan of $50,000 from Interactive Brokers. Assume that on Day 2 the market value of the securities falls to $71,427. Under this scenario, the customer's margin loan from the firm would remain at $50,000, and the customer's account equity would fall to $21,427 ($71,427 market value less $50,000 loan amount). However, since Interactive Brokers' minimum maintenance margin requirement is 30%, meaning that the customer's equity must not fall below $21,428 ($71,427 market value multiplied by 30%), Interactive Brokers will automatically liquidate a portion of Customer's margined position, without notice to the customer and without providing the customer an opportunity to deposit additional funds. Since Interactive Brokers requires that a Customer, following an automatic liquidation, have available funds equal to Interactive Brokers' minimum margin maintenance requirement at the time of liquidation, Interactive Brokers will attempt to automatically liquidate in 100 share increments an amount of stock that, following the automatic liquidation, will provide Customer's account with equity which exceeds Interactive Brokers' minimum maintenance margin requirement at the time of liquidation.


  2. Customer places an order to sell 10,000 shares of XYZ stock short at a time when the price of XYZ stock is bid $10 per share, or a current market value of $100,000. Prior to effecting a short sale order for a Customer, (a) the Customer must have equity in its account at least equal to the IB's initial margin requirement and (b) Interactive Brokers must be able to borrow the stock on behalf of Customer. Interactive Brokers will determine whether it can borrow the 10,000 shares of XYZ stock. If it cannot borrow 10,000 shares of XYZ stock, Interactive Brokers will not effect the short sale. If it can arrange to borrow 10,000 shares of XYZ stock, Interactive Brokers will attempt to execute the short sale of XYZ stock and borrow 10,000 shares of XYZ stock for Customer. Assume that Interactive Brokers initial margin requirement for a short sale is 50% and its minimum maintenance requirement for a short sale is (a) 30% for underlying stock priced $17.00 per share or more; or $5.00 per share for stock priced between $5.00 and 16 7/8 per share; or, for stock priced less than $5.00 per share, the greater of 100% or $2.50 per share. Interactive Brokers will not attempt to effect the short sale unless Customer has equity in an Interactive Brokers securities account of at least $50,000. Assuming Customer has account equity of $50,000, prior to placing the short sale order, following execution the Customer's account will be credited with the proceeds from the short sale, $100,000, bringing the cash balance to $150,000 (less commissions and fees). The account equity remains at $50,000 ($150,000 cash balance less $100,000 value of short stock position). However, if XYZ stock rises in value to any amount above $116,000 (at which point the customer's equity ($34,000) will fall short of the 30% minimum maintenance requirement) Interactive Brokers will attempt to automatically liquidate in 100 share increments an amount of stock that, following the automatic liquidation, will provide Customer's account with equity which exceeds Interactive Brokers' minimum maintenance margin requirement at the time of liquidation.

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Futures FAQs

What is the S&P 500® Index?

The S&P 500 Index is one benchmark by which the US stock market's performance can be measured. The S&P 500 Index is based on the stock prices of 500 large-capitalization companies and represents a broad cross-section of the US equity market. The Index values are exclusive of dividend income, and reflect only price action of the underlying stocks. Since the Index is capitalization weighted (shares outstanding x stock price), each company's influence on Index performance is directly proportional to its market value.

Generally, an investor who expects the stock market to rise might buy E-Mini S&P 500 Futures Contracts instead of purchasing individual stocks. The investor could profit if the market rises and lose if it declines. Conversely, an investor who expects the market to decline might buy E-Mini S&P 500 Put Options, and profit if the market declines, or lose if it rises.

The price of the E-Mini S&P 500 Futures and Options Contracts closely tracks the level of the S&P 500 index. However, prices may be higher or lower because factors impact the price of futures, options and the cash price of the underlying 500 stocks in the S&P 500 index. Examples of such factors include the facts that the owner of the underlying stock receives dividends on stocks, while the owner of E-Mini S&P Futures and Options Contracts does not; and the buyer of the underlying stocks pays cash or borrows to pay for the stock, while the buyer of the E-Mini Futures deposits margin. The difference between the cash price and the futures price is called the cost of carry. Factors which affect the value of options include their time value, which has several components such as the amount of time remaining until expiration, and volatility.

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What is the E-MiniTM S&P 500® Futures Contract?

A futures contract is an agreement to buy or sell a specified quantity of a commodity at a specified price and at a specified date in the future. E-Mini S&P 500 Futures Contracts are legally binding agreements to buy or sell the cash value of the S&P 500 Index at a specific future date. The symbol is: "ES", and the contract trades on the Chicago Mercantile Exchange's GLOBEX® 2 System. The GLOBEX 2 System is a small-order (30 contracts or less) electronic order routing and execution system which allows quick trade execution virtually 24 hours a day. The contracts are valued at $50 x the futures price. For example, if the E-Mini price is at 920.00, the value of the contract is $46,000 ($50 x 920.00). The E-Mini Futures Contract months are March, June, September and December. The settlement date for each quarterly futures contract month is the third Friday of that contract month.

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What is the E-MiniTM S&P 500® Options Contract?

An option on a futures contract conveys the right, not the obligation, to assume a position in the underlying futures market at a specific price any time before the option expires. A call option on a futures contract is the right to buy a futures contract. A put option is the right to sell a futures contract. The symbol is "ES" followed by expiration month and year and strike price, for example ES OCT98 1170. The underlying instrument for each E-Mini S&P 500 Options Contract is one E-Mini S&P 500 Futures Contract. The dollar value of an option contract is $50 x the premium, or price, of the option. For example, if the September 925.00 call has a premium of 7.00, the dollar value of the E-Mini S&P 500 Option would be $350 ($50 x 7.00). Strike, or exercise, prices for E-Mini S&P 500 Options are in 5-point increments (e.g., 915.00, 920.00, 925.00) for the two nearby contracts, and in 10-point increments (e.g., 910.00, 920.00, 930.00) for the deferred months.

There are twelve E-Mini Option Contract Months. The E-Mini S&P 500 quarterly cycle options settle in cash during a Special Opening Quotation on the morning of the third Friday of the contract month. Non-quarterly, or serial, options (i.e., Jan, Feb, Apr, etc.) stop trading at 3:15 (US CST) on the third Friday of the contract month and settle into the nearest futures contract.

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What is the SMI® Index?

The SMI® Index is a capital-weighted, non-dividend-adjusted index featuring up to 25 liquid large-cap stocks (blue chips) traded on the Swiss equity market, representing about 80% of the total capitalization. The index was first calculated on June 1998, at a level of 1500. The capital factor (k) was determined such that the product of total capitalization and k factor resulted in an index figure of 1500 points. The market capitalization is calculated on the basis of the number of stocks in circulation. The SMI® Index is calculated real-time. As soon as a trade is concluded in one or more SMI® stocks, the index is recalculated. The index level is published every second via Swiss Market Feed (SMF) if a new trade is concluded. Only those prices negotiated for trades concluded on-exchange (i.e., on the Swiss Exchange) are factored into the index calculation. As trading in SOFFEX products such as stock options and futures is conducted solely on the basis of SMI® securities, this index has significant importance for professional market operators.

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What is the SMI® Futures Contract?

SMI® Futures Contracts are legally binding agreements to buy or sell the cash value of the SMI® Index at a specific future date. The symbol is: "SMI", and the contract trades on the Eurex. Eurex is a jointly owned subsidiary of Deutsche Borse AG and the SOFFEX, each of which holds a 50 percent stake in the company. As the hub of a forward-looking electronic futures market, Eurex is open to other exchanges. The subsidiary Eurex Clearing AG offers participants fully integrated and automated clearing facilities for all products and offers an electronic order routing and execution system which allows quick trade execution between the hours of 8:30 a.m. until 5:00 p.m. Switzerland time (CET). The contracts are valued at CHF 10 per SMI Index Point. For example, if the SMI price is at 1000.00, the value of the contract is CHF 10,000 (CHF 10 x 1,000). The SMI Contract months are March, June, September and December. The settlement date for each contract month is the third Friday of the expiration month, if that is an exchange trading day; otherwise, on the exchange trading day immediately prior to that Friday. Trading in the expiring futures contract stops at 9:00 a.m. CET on the last trading day. See the Eurex website for further details and Contract Specifications.

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What is the SMI® Options Contract?

The symbol for the SMI Options Contract is OSMI [followed by expiration month and year and strike price], for example OSMI DEC98 6200. The underlying instrument for the SMI Options Contract is the Swiss Market Index (SMI®). The dollar value of an SMI option contract is CHF 10 per SMI index point, or price of the option. For example, if the December 6200 call has a premium of CHF 5, the price to be paid for 1 SMI Options Contract would be CHF 50 (CHF 10 x 5). Strike, or exercise, price gradations for SMI Options are as follows: (i) for contract months with a duration of 1 - 9 months, there will be 9 strike prices with an exercise price gradation in 50 index points; (ii) for contract months with a duration of 12 months, there will be 5 strike prices with an exercise price gradation in 100 index points; (iii) for contract months with a duration of more than 12 months, there will be 5 strike prices with an exercise price gradation in 200 index points. The quotation of the SMI Options Contracts is in points, carried out one decimal place. The minimum price movement is dependent upon the option price, as follows:

Option Price Minimum Price Movement
CHF 0.10 - CHF 9.90
CHF 0.10
CHF 10.00 - CHF 19.80
CHF 0.20
CHF 20.00 - CHF 299.50
CHF 0.50
CHF 300.00 and above
CHF 1.00

The SMI Options Contract months are the three nearest calendar months, the three following months within the cycle March, June, September and December, as well as the two following months of the cycle June and December; i.e., options contracts are available with a duration of 1, 2, 3, maximum 6, maximum 9, maximum 12, as well as maximum 18 and maximum 24 months. See the Eurex website for further details and Contract Specifications.

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What is the CAC 40 Stock Index?

The CAC 40 Stock Index (CAC 40), a weighted index of the monthly settlement stock market of the SBF-Bourse de Paris (the Paris Stock Exchange), consists of 40 "blue chip" stocks representing various economic sectors. It has a base value of 1,000 as of December 31, 1987 and is valued at 10 times the futures-quoted index. The CAC 40 Index is managed by an independent committee which changes the index as necessary to reflect changes in the market or in the capital of the index's constituent stocks; is reported to two decimal places, is calculated continuously by the SBF-Bourse de Paris, and is disseminated every 30 seconds. If securities representing more than 35% of the capitalization of the CAC 40 Index cannot be quoted temporarily, (either because of a technical incident, or due to a trading halt involving one or more of the issues in the sample), the index is replaced by a trend indicator known as an eclaireur. In this case, the published index value reflects only the variation in prices of the shares that are quoted. Participants should be extremely cautious in extrapolating those variations to the index as a whole, and they are entirely responsible for the underlying assumptions that they make. For more information you can visit the MONEP website.

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What is the CAC 40 Futures Contract?

CAC 40 Futures Contracts are legally binding agreements to buy or sell the cash value of the CAC 40 Index at a specific future date. The symbol is: "FCE". This contract trades on MONEP, solely through the NSC automated system. Orders for continuously quoted options and futures are entered into the NSC system throughout the trading session and matched on a regular basis. They are executed automatically whenever a counterparty is found.

CAC 40 Futures Contracts trade on a continuous basis in the following hours: (i) an evening sub-session from 5:00 p.m. to 10:00 p.m.; (ii) a morning session from 8:00 a.m. to 10:00 a.m.; and (iii) a daytime sub-session from 10:00 a.m. to 5:00 p.m. (all times are Paris time). The contract is denominated in Euros, valued at EUR 10 for each CAC 40 index point; is quoted in points (carried out to one decimal place); and has a minimum price movement of 0.5 index points, representing a value of EUR 5 per contract (0.5 x EUR 10). Each trading unit equals the CAC 40 Index Value x EUR 10; for example, if the CAC 40 futures price is at 4000.0, the value of the contract is EUR 40000 (EUR 10 x 4000.0). The daily price fluctuation of the CAC 40 futures contract is limited to +/- 190 index points relative to the previous day's settlement price; if one of the two nearest futures maturities exceeds this limit, trading is temporarily halted in CAC 40 futures contracts. The circuit breaker will also be activated if a market imbalance leads to the suspension of trading in a sample group of stocks that together represent more than 75% of the capitalization of the CAC 40. Trading in the CAC 40 Futures Contracts takes place on eight open maturities including three spot months, three quarterly maturities of the March, June, September and December cycle, and two half-yearly maturities (March, September cycle). A maturity's last trading day is the last trading day of the delivery month at 4:00 p.m. A new delivery month is created on the first trading day following the closing of the previous delivery month. There is no delivery of shares at expiration; the CAC 40 futures contract is cash-settled. See the MATIF website for further details and Contract Specifications.

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What is the Short-term CAC 40 Options Contract?

The symbol for the Short-term CAC 40 Options Contract is PX1 [followed by expiration month and year and strike price], for example PX1 JUN99 5300. The underlying instrument for the Short-term CAC 40 Options Contract is the CAC 40 Index.

The value of a Short-term CAC 40 Options Contract is EUR 1 per CAC 40 index point, or price of the option. For example, if the June 1999 5300 call has a premium of EUR 20, the price to be paid for 1 PX1 Options Contract would be EUR 20 (EUR 20 x 1). Strike, or exercise, prices are set at standard intervals of 150 index points each. They are different for calls and puts. When a maturity opens gradations for ODAX Options are as follows: (i) for contract months with a duration of 1 - 9 months, there will be 9 strike prices with an exercise price gradation in 50 index points; (ii) for contract months with a duration of 12 months, there will be 5 strike prices with an exercise price gradation in 100 index points; (iii) for contract months with a duration of more than 12 months, there will be 5 strike prices with an exercise price gradation in 200 index points. The quotation of ODAX Options Contracts is in points, carried out one decimal place. The minimum price movement is 0.10 of a point, representing a value of EUR 1. Trading takes place on a continuous basis between 10:00 a.m. and 5:00 p.m. (Paris Time). Quotation of expiring series ceases at 4:00 p.m. (Paris Time) on their expiration day.

The PX1 Options Contract months are the three consecutive nearby months (including the month in progress), and the quarterly maturity months (March, June, September and December cycle) immediately following those three months. Once the outstanding quarterly maturity's remaining life diminishes to three months, a new quarterly maturity is created. Strike prices are set at standard intervals of 25 index points each (e.g., 4100, 4125, etc.). When a maturity opens, call and put series are created for the five strike prices closest to the index value: one "at the money", two "in the money" and two "out of the money".

The daily price fluctuation of the CAC 40 futures contract is limited to +/- 175 index points relative to the previous day's settlement price; if one of the two nearest futures maturities exceeds this limit, trading is temporarily halted in CAC 40 futures contracts and in short-term and long-term CAC 40 options. The circuit breaker will also be activated if a market imbalance leads to the suspension of trading in a sample group of stocks that together represent more than 75% of the capitalization of the CAC 40.

When a PX1 Options Contract is exercised by its holder, a writer is assigned at random. Settlement takes the form of a cash transfer equal to the difference between the PX1 Options Contract strike price and the value of the day's (or the expiration's) settlement index. The daily settlement index is the mean of all index values calculated and disseminated between 4:40 p.m. and 5:00 p.m. (Paris Time) (including the first index value calculated and disseminated after 5:00 p.m. (Paris Time). The expiration settlement index used as a reference for automatic exercise of contracts that are in-the-money at maturity is the mean of all index values calculated and disseminated between 3:40 p.m. And 4:00 p.m. (Paris Time) on the expiration date (including the first index value disseminated after 4:00 p.m.). the daily cutoff for registering exercise instructions is set at 5:45 p.m. (Paris Time). On the expiration day, in-the-money options are automatically exercised, unless contrary instructions are received from the participant. See the MONEP website for further details and Contract Specifications.

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What is the Hang Seng Index (Futures and Options)?

(Text reprinted from HKFE website)

Hang Seng Index (HSI), the benchmark of the Hong Kong stock market, is one of the best known indices in Asia and widely used by fund managers as their performance benchmark. The Hang Seng Index is a market capitalization-weighted index (shares outstanding multiplied by stock price) of the 33 constituent stocks. The influence of each stock on the index's performance is directly proportional to its relative market value. Constituent stocks with higher market capitalization will have greater impact on the index's performance than those with lower market capitalization. The 33 constituent stocks are grouped under Commerce and Industry, Finance, Properties and Utilities sub-indices. These stocks account for about 70% of the total market capitalization of all stocks listed on The Stock Exchange of Hong Kong Ltd. (SEHK). or:
http://www.hkfe.com


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What is the Mini-Hang Seng Index Futures?

(Text reprinted from HKFE website)

To meet the needs of retail investors with an interest in the Hong Kong stock market, the Hong Kong Futures Exchange (HKFE) will introduce a Mini-Hang Seng Index (Mini-HSI) futures contract on 9 October 2000. The compact, Mini-HSI futures contract is based on Hong Kong's benchmark Hang Seng Index (HSI), which is also the underlying index for the larger sized HSI futures contract. The contract multiplier of the Mini-HSI futures contract is HK$10.00 or one-fifth the size of the HSI Futures contract. Hence, the mini contract will be worth HK$175,000.00 if the HSI futures price is at 17,500 level. Same as the HSI futures contract, the settlement method for the mini contract is cash settled. Local retail investors who have less risk capital and lower hedging requirements will find the Mini-HSI futures contract the most appropriate investment tool as well as hedging instrument for managing their market risk.

The Mini-HSI futures contract inherits the advantages of the larger sized HSI futures contract but is tailored for individuals with limited risk capital. Its smaller contract size allows experienced and novice investors alike to participate in the performance of 33 constituent stocks in the index in a graduated scale.

http://www.hkfe.com

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What is the Hang Seng 100® Index?

The Hang Seng 100 Index is one barometer of the performance of the Hong Kong stock market. The Hang Seng 100 Index is based on the stock prices of 100 companies to provide a broader representation of the Hong Kong market as compared to the Hang Seng Index. The Index values are exclusive of dividend income, and reflect only price action of the underlying stocks. Since the Index is capitalization weighted (shares outstanding x stock price), each company's influence on Index performance is directly proportional to its market value.

Generally, an investor who expects the stock market to rise might buy Hang Seng 100 Futures Contracts instead of purchasing individual stocks. The investor could profit if the market rises and lose if it declines. Conversely, an investor who expects the market to decline might sell Hang Seng 100 Futures Contracts, and profit if the market declines, or lose if it rises.

The price of the Hang Seng 100 Futures Contracts Futures and Options Contracts closely tracks the level of the Hang Seng 100 Index. However, prices may be higher or lower because factors impact the price of futures, options and the cash price of the underlying 100 stocks in the Hang Seng 100 Index. Examples of such factors include the facts that the owner of the underlying stock receives dividends on stocks, while the owner Hang Seng 100 Futures and Options Contracts does not; and the buyer of the underlying stocks pays cash or borrows to pay for the stock, while the buyer of the Hang Seng 100 Futures deposits margin. The difference between the cash price and the futures price is called the cost of carry. Factors which affect the value of options include their time value, which has several components such as the amount of time remaining until expiration, and volatility.

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What is the Hang Seng 100® Futures Contract?

Hang Seng 100 Futures Contracts are legally binding agreements to buy or sell the cash value of the Hang Seng 100 Index at a specific future date. The symbol is: "HHIF", and the contract trades on the Hong Kong Future Exchange's (HKFE) Automated Trading System (ATS). The trading method employed by the HKFE is electronic order matching through an automated execution system. Trading is available in two sessions, as follows: 9:45 a.m. - 12:30 p.m. Hong Kong time (the first trading session) and from 2:30 p.m. - 4:15 p.m. Hong Kong time (except on the Last Trading Day, when the second session ends at 4:00 p.m. Hong Kong time). The contracts are valued at HKD 1,000 per index point. For example, if the Hang Seng 100 Futures Contract price is at 90.00, the value of the contract is HKD 90,000 (HKD 1,000 x 90.00). The Hang Seng 100 Futures Contract months are the Spot Month, the next calendar month, and the next two calendar quarterly months (March, June, September and December). The settlement date for each contract month is the first business day after the last trading day; the last trading day is the business day immediately preceding the last business day of that contract month. The execution of Hang Seng 100 Futures Contracts are subject to a HKD 10.00 fee and levy per contract per side in addition to the commissions and fees charged by Interactive Brokers. See the HKFE website for further details and Contract Specifications.

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What is the Hang Seng 100® Options Contract?

The symbol for the Hang Seng 100 Options Contract is HHI [followed by the strike price, expiration month and year], for example HHI85A9. The underlying instrument for the Hang Seng 100 Options Contract is the Hang Seng 100 Index.

The value of a Hang Seng 100 Options Contract is HKD 1,000 per Hang Seng Index point, or price of the option. For example, if the January 1999 90 call has a premium of HKD 3.00, the price to be paid for 1 Hang Seng 100 Options Contract would be HKD 3,000 (HKD 1000 x 3). Strike, or exercise, price gradations for Hang Seng 100 Options are set at intervals of one (1) index point with a minimum fluctuation of 0.01 index point (representing HKD 100). Options premiums are quoted in index points up to two (2) decimal places.

The Hang Seng 100 Options Contract months are the Spot Month, the next two (2) calendar months, and the next three (3) calendar quarterly months (March, June, September and December). The Expiry (or expiration) Date for each options contract month is the business day immediately preceding the last business day of the contract month. The final Settlement Day is the business day immediately following the Expiry Day of that contract month. Trading is available in two sessions, as follows: 9:45 a.m. - 12:30 p.m. Hong Kong time (the first trading session) and from 2:30 p.m. - 4:15 p.m. Hong Kong time (except on the Last Trading Day, when the second session ends at 4:00 p.m. Hong Kong time). The execution of Hang Seng 100 Options Contracts is subject to a HKD 10.00 fee and levy per contract per side in addition to the commissions and fees charged by Interactive Brokers. In addition, options exercised on the the Expiry Day are subject to an exercise fee of HKD 8.50 per contract

Exercise of Hang Seng 100 Options Contracts is European style, i.e., an option may only be exercised on the Expiry Day and settle in cash based on the Official Settlement Price. The Official Settlement Price for Hang Seng 100 Options Contracts shall be a number down to two decimal places, determined by the HKFE Clearing House, and shall be the average of the values of the Hang Seng 100 taken at five minute intervals during the Expiry Day. See the HKFE website for further details and Contract Specifications.

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What is DAX?

The Deutscher Aktienindex (DAX ) is comprised of 30 German blue chip stocks, quoted in continuous first segment or second segment trading at FWB Frankfurter Wertpapierborse. The criteria for including a stock corporation in the DAX are the volume of trading in its stock within the last 12 months, its market capitalization and the acceptance of the " bernahmekodex" (take over code). The DAX is constructed as a real-time index and is computed and published every 15 seconds using prices from the FWB Frankfurter Wertpapierborse (8.30 a.m. - 5.00 p.m.). Additionally, the DAX is calculated during the Xetra trading hours (8.30 a.m. - 5.15 p.m.). The index is based on Laspeyres' formula which is chained quarterly. All income from dividends and rights issues are reinvested in the index portfolio. The DAX is adjusted by share specific correction factors according to the "operation blanche". The index weighting is adjusted as part of the quarterly chaining procedure. The DAX price index is calculated in addition to DAX once a day based on closing prices from the Frankfurt Stock Exchange: dividends and bonuses are not reinvested. A "Kassa Index" is computed once a day for all share indices as soon as the "Kassa" prices for all shares included in the index are available. These contracts are stated in Euros. For more information you can visit the EUREX website.

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What is the DAX Futures (Round Lot) Contract?

DAX Futures (Round Lot) Contracts are legally binding agreements to buy or sell the cash value of the 30 largest components of DAX Index at a specific future date. The symbol is: "FDAX". This contract trades on EUREX, a fully electronic exchange which allows quick trade execution. You can visit EUREX at http://www.eurexchange.com (all products of the former organizations SOFFEX and DTB are now being traded on the EUREX-network).

The FDAX Futures Contracts are available for trading from 8:25 a.m. until 10:00 p.m. Germany Time (CET). The contract is valued at EUR 25 per DAX index point; are quoted in points (carried out to one decimal place); and the minimum price movement is 0.5 of a point, representing a value of EUR 12,50. For example, if the FDAX futures price is at 5300.0, the value of the contract is EUR 132,500 (EUR 25 x 5300.0). FDAX Futures Contracts are denominated in Euros. The FDAX Futures Contract months are March, June, September and December. The last trading day for each contract month is the third Friday of the expiration month, if that is an exchange trading day; otherwise, it is on the exchange trading day immediately prior to that Friday. Trading in the expiring futures contract ceases at the start of the intra-day trading rotation on the Xetra electronic trading system, as determined by the management of the Frankfurt Stock Exchange. The final settlement price shall be the value of the DAX index, determined on the basis of the collective prices of the shares contained in the DAX index on the last trading day, as reflected in the intra-day trading rotation on Xetra. See the EUREX website for further details and Contract Specifications.

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What is the DAX Options (Round Lot) Contract?

The symbol for the DAX Options (Round Lot) Contract is ODAX [followed by expiration month and year and strike price], for example ODAX MAR99 5300. The underlying instrument for the DAX Options (Round Lot) Contract is the Deutscher Aktienindex (DAX ).

The value of an ODAX Options Contract is EUR 5 per DAX index point, or price of the option. For example, if the March 1999 5300 call has a premium of EUR 20, the price to be paid for 1 ODAX Options Contract would be EUR 100 (EUR 20 x 5). Strike, or exercise, price gradations for ODAX Options are as follows: (i) for contract months with a duration of 1 - 9 months, there will be 9 strike prices with an exercise price gradation in 50 index points; (ii) for contract months with a duration of 12 months, there will be 5 strike prices with an exercise price gradation in 100 index points; (iii) for contract months with a duration of more than 12 months, there will be 5 strike prices with an exercise price gradation in 200 index points. The quotation of ODAX Options Contracts is in points, carried out one decimal place. The minimum price movement is 0.1 of a point, representing a value of EUR 0,50.

The ODAX Options Contract months are the three nearest calendar months, the three following months within the cycle March, June, September and December, as well as the two following months of the cycle June and December; i.e., options contracts are available with a duration of 1, 2, 3, maximum 6, maximum 9, maximum 12, as well as maximum 18 and maximum 24 months.

The final settlement price shall be the value of the DAX index, determined on the basis of the collective prices of the shares contained in the DAX index on the last trading day, as reflected in the intra-day trading rotation on Xetra. See the EUREX website for further details and Contract Specifications.

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What is the FTSE 100 Index?

The Financial Times-Stock Exchange (FTSE) 100 index, which came into use in 1984, tracks the share price movements of the top 100 United Kingdom companies. It is calculated every minute during each trading day (08:30 - 16:30). For more information, visit The London International Financial Futures and Options Exchange (LIFFE) at the LIFFE website, particularly the publication, "Equity & Index Options, an Introduction to equity and index".

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What is the FTSE 100 Index Futures Contract?

FTSE 100 Index Futures Contracts are legally binding agreements to buy or sell the cash value of the 100 largest components of the FTSE 100 Index at a specific future date. The symbol is: "FTSE". On May 10, 1999, this contract will commence trading through the LIFFE CONNECT trading platform, transforming the LIFFE's "Open Outcry" trading floor into a fully electronic exchange which allows quick trade execution by matching orders pursuant to a trade matching algorithm. You can visit LIFFE at http://www.liffe.com.

The FTSE Futures Contracts are available for trading from 08:35 a.m. until 16:30 p.m. London Time (CET). The contract is valued at 10 per FSTE 100 index point; is quoted in index points and the minimum price movement is 0.5 point ( 5.00). For example, if the FTSE futures price is at 6600.0, the value of the contract is 66,000 ( 10 x 6600.0). The FTSE Futures Contract (Delivery) months are March, June, September and December. The Last Trading Day for each contract month is the third Friday of the Delivery month, unless the third Friday is not a business day, in which case the Last Trading Day shall normally be the last business day preceding the third Friday. Trading in the expiring futures contract stops at 10:30 GMT on the Last Trading Day. The cash settlement price shall be based on the Exchange Delivery Settlement Price (EDSP), which is based on the average values of the FTSE 100 Index every 15 seconds inclusively between 10:10 and 10:30 London time on the Last Trading Day. Of the 81 measured values, the highest 12 and lowest 12 will be discarded and the remaining 57 will be used to calculate the EDSP. Where necessary, the calculation will be rounded to the nearest half index point. See the LIFFE website for further details and Contract Specifications.

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What is the FTSE 100 Index Options (European Style Exercise) Contract?

The underlying instrument for the FTSE 100 Index Options (European Style Exercise) Contract is the FTSE 100 Index.

The value of a FTSE 100 Index Options (European Style Exercise) Contract is 10 per FTSE 100 index point, or price of the option. Prices for options on individual stocks are quoted in pence per share. One equity option contract usually represents 1000 share. Thus the price of 1 FTSE Index option is to be multiplied by 10. For example, if the June 1999 FTSE 100 option contract is quoted at a price of 30, the option will cost 300 per contract (30 x 10). Strike, or exercise, price intervals for 1999 FTSE 100 options is determined by the time to maturity of a particular expiry month and is either 50 or 100 index points. The Expiry months are: (i) March, June, September and December, plus (ii) such additional months that the 3 nearest calendar months are always available for trading. The quotation of FTSE 100 Options Contracts is in index points, carried out one decimal place. The minimum price movement is 0.5 of a point, representing a value of 5.00.

The final settlement price, or Contract Standard is the cash settlement price and shall be based on the Exchange Delivery Settlement Price (EDSP), which is based on the average values of the FTSE 100 Index every 15 seconds inclusively between 10:10 and 10:30 London time on the Last Trading Day. Of the 81 measured values, the highest 12 and lowest 12 will be discarded and the remaining 57 will be used to calculate the EDSP. Where necessary, the calculation will be rounded to the nearest half index point. Exercise of the options is European style, i.e., an option may only be exercised on the Last Trading Day of the expiring options series by 18:00 (London time). The Last Trading Day is the third Friday of the expiry month, unless the third Friday is not a business day, in which case the Last Trading Day shall normally be the last business day preceding the third Friday. Settlement Day is the first business day after the Last Trading Day. See the LIFFE website for further details and Contract Specifications.

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Option Strike Price

The strike or exercise price of an option is the specified price at which the product underlying the option can be bought or sold if the buyer exercises the right to buy (in the case of a call) or sell (in the case of a put).

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Option Premium

The option premium is the price at which the option contract trades, i.e. the price of the option, and is paid by the buyer to the writer, or seller, of the option. The full premium, or total amount payable for an option contract equals the unit price x the option contract multiplier. In return, the writer of the call option is obligated to deliver the product underlying the option to an option buyer if the call is exercised, or buy the underlying product if the put is exercised. The writer keeps the premium whether or not the option is exercised.

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Exercising Futures Options

The buyer, or holder, of an option may exercise the option to purchase or sell the underlying product at the option strike price. In the case of the E-Mini S&P 500 option, the underlying is the E-Mini S&P 500 futures contract. For "Long Options Only Accounts", Interactive Brokers' Customers may not exercise options, and must close-out positions by offsets. Nevertheless, it is important to understand the exercise process.

For example, if the holder of 1 E-Mini S&P 500 NOV 970 Call Option decided to exercise the option (because the underlying E-Mini S&P 500 Futures Contract was trading at a price of, say, 990.00), the exercise of the option would obligate the writer (the seller of the option to the holder) to deliver 1 E-Mini S&P 500 Futures Contract to the holder at a price of 970.00, resulting in an unrealized profit to the holder of $1,000 ([990.00-970.00] x $50). The profit would be realized if the holder were to actually sell 1 E-Mini S&P 500 Futures Contract to offset the holder's newly created futures position.

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Option Contract Multiplier

The option contract multiplier is used to determine the full premium or total market value of an option contract and also denotes the number of shares of underlying stock deliverable upon exercise of an equity option.

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Price Movements

The minimum price movement of an options or futures contract is called a tick. For example, the tick value of the E-Mini S&P 500 Options and Futures Contract is .25 index points, or $12.50 (.25 x the $50 contract multiplier). This means that if the price of the E-Mini Futures moves one tick, for example, from 920.00 to 920.25, a long (buying) position would earn $12.50; and a short (selling) position would lose $12.50. Price limits, or daily trading limits specify a maximum price range imposed by an exchange for a contract. The price limits for the E-Mini follow the existing S&P 500® Futures Contract circuit breakers so that trading in the E-Mini Options and Futures Contracts is halted when trading in the S&P 500 Futures is halted. See Retail Products Page for details.

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Margin For Futures

In order for an Interactive Brokers Customer to trade, the Customer must have on deposit original (or initial) margin (also referred to as a performance bond) which represents a percentage of the total value of the position. Margin acts as a good faith deposit to ensure that investors will pay for losses resulting from contract performance. Interactive Brokers' current margin requirements can be found on the IB Margin Requirements page.

Futures positions are marked-to-market which means the value of the futures position is continuously updated as the market moves. Interactive Brokers Customers are required to monitor their positions and are responsible for ensuring that they deposit additional margin in their accounts to prevent their Account Balance from falling below the required maintenance level to avoid possible forced liquidation of positions. Conversely, if there are gains on open positions, a customer may be permitted to withdraw excess variation margin from the account. New positions can be established only if a Customer's account has sufficient funds to meet initial margin requirements for all open positions. Margin requirements are subject to change on notice to Customers.

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Close-Outs

Because the IB System operates automatically, Customers must monitor their account equity to be sure that there are sufficient funds on deposit to meet margin requirements. If an account does not have sufficient funds to meet margin requirements, Interactive Brokers is entitled to close-out the account at once, without providing notice to the Customer. Interactive Brokers is also directed but not obligated, to utilize excess margin in one account to meet margin requirements in one or more other accounts of the same customer. Although the IB System is designed to mark the Customer's position to the market, whether or not the IB System performs this function adequately at any particular time, it is the Customer's obligation to determine whether additional maintenance margin is or may soon be required to avoid a close-out. INTERACTIVE BROKERS DOES NOT MAKE MARGIN CALLS FOR PURPOSES OF REQUESTING ADDITIONAL CASH/ASSET DEPOSITS; IB MAY MAKE A MARGIN CALL TO COMPLY WITH VARIOUS REGULATORY REQUIREMENTS AND IS REQUIRED TO ACT IN ACCORDANCE WITH THESE REGULATIONS. IB HAS NO OBLIGATION TO WARN CUSTOMERS OF IMPENDING CLOSE-OUTS; AND IT SHALL HAVE NO LIABILITY FOR FAILURE TO DO SO. Even if a Customer's account is under margined and a close-out is not performed by Interactive Brokers, the Customer remains responsible for any losses in the account.

ZB, ZN, ZF are set to close out starting before the open outcry close on the last day while ZT will use the entire last day to close out.

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An Example of How Margin on Futures Works

The following example demonstrates how margin works. On December 1, 1997, a Customer buys 1 March E-Mini S&P 500 Futures Contract at a price of $900.00.

Trade Date Futures Price Account Equity
Comments
12/01 900.00 $5,000 The Customer deposited original margin of $5,000, providing the account with equity, and established a long E-Mini Futures position. If the equity declines 40% below the minimum current margin requirement, a deposit of maintenance margin will be required to avoid a possible close-out.
12/02 890.00 $4,500 The price of the E-Mini Futures Contract declined 10 points so the account equity declined $500 (10 x $50). Since the account is marked-to-market, the Customer should know that additional maintenance margin will be required before the E-Mini declines by more than 30 points. By viewing the Interactive Brokers Trading Screen, messages may provide the status of required margin.
12/03 859.00 $2,950 The price of the E-Mini declined 31 points. If the Customer had not deposited additional funds in the account prior to the decline, the account equity would be reduced by $1,550 (31 x $50 ) to $2,950, in which event the account would have been under margined, and the IB System may attempt to close-out of the position if conditions permit. Interactive Brokers would have discretion as to the timing of the close-out and the Customer would be responsible for all losses, whether or not close-out is attempted in a timely fashion.

NOTE: The Customer is obligated to maintain a sufficient Account Balance to meet the required maintenance margin level and avoid a possible close-out.

12/03 859.00 $4,500 The equity increased because $1,550 was wired in the account. This deposit avoided a close-out.
12/04 875.00 $5,300 The price of the E-Mini Futures Contract increased 16 points, increasing the equity in the account by $800 (16 x $50).
12/05 905.00 $6,800 The price of the E-Mini again increased 30 points and the Customer now has excess maintenance margin of $1,800 (above the $5,000 original margin requirement). The excess margin can be withdrawn from the account.

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Market Conditions

Under certain market conditions, it may not be possible for Interactive Brokers to liquidate a Customer's position at all, or at the then prevailing market price, and the position may continue to lose value in excess of the equity in the account. The customer will be responsible for such losses. Such market conditions include fast markets, illiquid markets, and locked limit markets.

Fast Market: In the event prices are moving rapidly, the exchange may declare a "Fast Market". In this market condition, a broker may not be able to execute a limit order.

Illiquid Market: If there are not enough buyers or sellers in the market, it may be difficult or impossible to execute an order.

Locked Limit Market: A limit move is a price move in either direction equal to the price limit at which the exchange has declared that trading must cease for a period of time at prices beyond the limit move. If a market reaches the limit it is said to be locked limit. The limits are set out in the contract specifications set out on the Retail Products Page. If a contract reaches the limit on the upside, the contract is said to be "limit up". If it reaches the limit on the down side, it is said to be "limit down". The Chicago Mercantile Exchange has determined that if the S&P 500 Index Futures Contract reaches its price limit, then the E-Mini will cease trading.

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Futures Contracts Not Settled in Cash

For futures contracts that are settled by actual physical delivery of the underlying commodity (“physical delivery futures”), customers may not make or receive delivery of the underlying commodity. Certain currency futures are excepted from this rule (see table below).

To avoid deliveries in expiring futures contracts, customers must roll forward or close out positions prior to a “Close-Out Deadline”. The standard Close-Out Deadline for holders of long positions is the end of the fourth (4th) business day prior to the exchange specified ‘First Notice Day’. For holders of short positions, the standard Close-Out Deadline is the end of trading on the fourth (4th) business day prior to the exchange-specified last trade day. Certain contracts use a different time ahead of the Close-Out deadline as specified in the following table.

It is the Customer's responsibility to make itself aware of the "Close-out Deadline". If a customer has not closed out a position in a physical delivery futures contract by the "Close-Out Deadline", IB may, without additional prior notification, liquidate the customer’s position in the expiring futures contract. Please note that liquidations will not otherwise impact working orders; customers must ensure that open orders to close positions are adjusted for the actual real-time position

Summary of Physical Delivery Futures Policies
Contract
Delivery Permitted
 Close-Out Deadline
ZB, ZN, ZF (ECBOT) No 2 hours before the end of open outcry trading on the First Notice Day (longs) or Last Trading Day (shorts)
ZT (ECBOT) No end of business day prior to the First Notice Day (longs) or Last Trading Day (shorts)
EUREXUS futures No same rules as for ECBOT equivalent contracts
GBL, GBM, GBS (Eurex) No 2 hours before the end of trading on the last trading day
GLOBEX currency futures (EUR, GBP, CHF, AUD, CAD, JPY, HKD) Yes Not applicable
All other contracts No end of the fourth business day prior to the First Notice Day (longs) or Last Trading Day (shorts)

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Cash-Settled Contracts E-Mini S&P 500 Futures Contracts and the E-Mini S&P 500 Options Contracts for the quarterly contract months (Mar, Jun, Sept and Dec) are settled in cash which means that there is no delivery of the individual stocks in the case of the futures contract or in the case of the Option Contract, there is no delivery of the underlying Futures Contract. E-Mini Futures Contracts are settled in cash using a Special Opening Quotation, on the morning of the third Friday of the quarterly contract month. The Special Opening Quotation is based on the opening prices of the underlying component stocks in the S&P 500 Index, or on the last sale price of a stock that does not open for trading on the regularly scheduled day of final settlement. For the serial E-Mini Options Contract months (i.e. Jan, Feb, Apr, etc.), the E-Mini Option settles into the underlying E-Mini S&P 500 Futures Contract.

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Uses of Futures and Options Contracts

The E-Mini S&P 500 Options and Futures Contracts can provide investors with a vehicle to pursue trading strategies based on the movement of the stock market as generally measured by the performance of the S&P 500 Index. Investors use it to:

  • Take a position on the broad market measured by the S&P 500 Index.
  • Protect or hedge stock portfolios against adverse changes in the stock market.
  • Diversify a securities portfolio.
  • Establish an approximate price for a future purchase or sale of securities.

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Buying Futures

An investor who expects the stock market to rise can take a bullish position by buying, for example, E-Mini S&P 500 Futures Contracts. Assume that on November 3, 1997 an investor purchased 10 E-Mini Futures Contracts at 900.00. If the stock market rallies and the E-Mini Futures Contract rises to 930.00, the investor can liquidate the 10 contracts and earn a profit of $15,000 (930.00 - 900.00 = 30 x 10 contracts x $50 multiplier per contract). If, on the other hand, the stock market declines and the E-Mini falls to 870.00, the investor would lose $15,000.

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Selling Futures

An investor who expects the stock market to fall can take a bearish position by selling, for example, E-Mini S&P 500 Futures Contracts. If the investor sold 5 E-Mini Contracts at 900.00 and the value of the E-Mini falls to 860.25, the investor can cover the position and buy the contracts back at a profit of $9,937.50 (900.00 - 860.25 = 39.75 x 5 x $50 contract multiplier). If, on the other hand, the E-Mini rises to 950.00, the investor would lose $12,500 [(900-950) x 5 x 50].

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Buying Call Options

An investor who expects the stock market to rise can take a bullish position by buying E-Mini S&P Call Options. For example, assume that an investor purchased 10 E-Mini 1150 Call Options at $7.50. If the stock market rallies and the E-Mini Futures Contract rises to 1200.00 before the Call Options expire, the E-Mini Calls may rise to a price of say 52.50, and the investor can liquidate the 10 E-Mini Calls and earn a profit of $22,500 [10 x (52.50 - 7.50) x $50], less the option premium paid. If, on the other hand, the E-Mini falls to 1100.00 before the Call Options expire, the price of the option may fall to $0.50 and, the investor would lose $3,500 [(10 x $7) x $50].

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Buying Put Options

An investor who expects the stock market to fall can take a bearish position by buying E-Mini S&P Put Options. If the investor bought 5 E-Mini 900.00 Put Options at $5.00, and the E-Mini falls to 860.25, the price of the option may rise to $40.00, and the investor would earn a profit of $8,750 [5 x (40.00 - 5.00) x $50], less the option premium paid. Conversely, if the E-Mini rises to 950.00 the price of the option may fall to $0.50, and the investor would lose $1,125 [5 x ($5.00 - 0.50) x $50], less the option premium.

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Selling Call Options

An investor who expects the stock market to fall can take a bearish position by selling (or "writing") E-Mini Call Options. For example, assume that an investor sold 5 E-Mini 900.00 Call Options at $5.00, he would receive a premium of $1,250 (5 x 5 x $50 per option contract) and, if the E-Mini Futures Contract falls to 860.00, the price of the call will also decline and the investor may profit by buying the call at such lower price. The investor may also speculate that the price of the E-Mini Futures Contract will not rise to the 900.00 strike price, and if the contract expires without reaching this strike price, the investor would profit by the amount of premium ($1,250) he was originally paid. On the other hand, if the E-Mini were to rally above the 900.00 strike price to 940.00, the investor would then be obligated to buy the E-Mini Futures Contract at 940.00, incurring a loss of $8,750 [5 x (940.00 - 900.00) x $50], or $10,000 less the $1,250 premium. The investor's potential loss would be UNLIMITED, since the underlying E-Mini Futures Contract can rise to any value.

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Selling Put Options

An investor who expects the stock market to rise can take a bullish position by selling (or "writing") E-Mini Put Options. If the investor sold 5 E-Mini 900.00 Put Options at $7.00, he would receive a premium of $1,750 (7 x $50 per option contract) and if the E-Mini Futures Contract rises in price to 930.00, the price of the Put will fall in value and the investor may profit by buying the put at a lower price. The investor may also speculate that the price of the E-Mini Futures Contract will not fall below the 900.00 strike price, and if the contract expires without reaching, or falling below, the 900.00 strike price, the investor would profit by the amount of premium ($1,750) he was originally paid. On the other hand, if the E-Mini were to fall below the 900.00 strike price prior to expiration, the investor may incur a loss. For example, suppose the E-Mini Futures Contract rises to 870.00 and the buyer of the put exercises the option written by the investor, the investor would then be obligated to buy the E-Mini Futures Contract at 900.00, incurring a loss of $5,750 [5 x (870.00 - 900.00) x $50], or $7,500, less the $350 premium. As with writing calls, the foregoing example demonstrates that an investor who writes puts has the potential to lose a significant amount of money; in the case of writing puts, the potential loss is measured as the difference between the strike price of the option and zero.

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Limit Orders

Interactive Brokers accepts limit orders for trading the E-Mini S&P 500 Options and Futures Contracts by those Customers who utilize the on-line registration services. A Futures Limit Order is an order in which the customer provides the contract month, the number of contracts to be bought or sold and the price. An Option Limit Order is an order which specifies the option series, the price and the number of contracts. If the limit order can be executed, it will be filled at the price specified, or a better price if one is available. A limit order cannot be filled at a price less favorable than the limit order price. If the market does not trade at the limit price or better while the order is pending, the customer will not get a fill. Orders are only valid for the session that they are entered. If the order is not executed by the end of the session it is canceled, and must be entered for the next session if the customer still wishes to make the trade.

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