Day Traders Are a New Wrinkle in the Negative Oil Price Mystery

(Bloomberg Businessweek) -- Add another possible cause for oil prices going negative for the first time ever in April: the day-trader effect.

A month after West Texas Intermediate crude oil futures settled at negative $37.63 on April 20, few conclusions have been reached as to what caused the crash. At first, people pointed to the outsize influence the enormous United States Oil Fund LP plays in crude. But it turns out the exchange-traded fund was out of the May contract at the time it breached zero. The shortage of available space to store oil at the key hub in Cushing, Okla., was another likely culprit, yet the market had known about that problem for weeks. Oil watchers then fingered the late selling by the Bank of China’s Crude Oil Treasure fund, but still, no definitive explanation has emerged.

What if it was a contingent of retail traders who were frozen out of trading when their brokerages were unable to process negative prices? A software glitch at Interactive Brokers Group trapped its retail clients, who were unable to buy or sell once oil went below zero. Chief Executive Officer Thomas Peterffy said traders on his platform made up 15% of the market on April 20. While the problems at Interactive are known, retail traders at rivals ETrade Financial Corp. and TD Ameritrade Holding Corp. were also frozen out of the market. Their brokerages also stopped working once prices went negative.

After May futures prices fell below zero on the afternoon of April 20, only 41 small-size contracts, the kind favored by retail investors, changed hands, according to exchange owner CME Group Inc. That could be a smoking gun suggesting the retail component of the market was absent at a time when it could have calmed trading.

When contracts are close to expiring, it’s usually only retail traders and a handful of commercial producers that want to take delivery of oil who are still buying and selling, says John Kilduff, founding partner at Again Capital Management LLC. The May contract that went negative on April 20 was set to expire the next day. “Most commercials and managed money were long gone,” Kilduff says. Professional investors generally have strict rules about not holding contracts near expiration. On that afternoon, he says, “the retail players saw the abject price collapse and tried to swoop in, thinking that zero was the lower bound, when it turned out that negative infinity is the lower bound.” Even so, those potential buyers and sellers, who might have stabilized the market, were shut out by software problems at their brokers.

Andy Lipow, president of Lipow Oil Associates LLC in Houston, says several factors combined to send oil below zero: A significant number of active contracts needed to be sold going into the close; some traders had the misperception that negative prices weren’t possible; and small traders were shut out of the market. “We saw the result, which was a significant price dislocation,” he says.

Interactive Brokers pledged to make its customers whole. The software failure will cost the company about $102.7 million, of which $14.7 million will go to customer refunds, according to the company.

Customers of ETrade and TD Ameritrade may not fare as well. Ben Whitesides was trading on ETrade from his home near Salt Lake City when he bought three 500 barrel oil contracts at an average price of 75¢ a barrel, he says. When prices turned negative, he wanted to sell immediately, but ETrade’s system froze. Whitesides says he couldn’t buy or sell, and was completely shut out. He estimated the most he could lose was about $1,500. Two days later, ETrade withdrew $57,000 from his account. “Their system had no ability to exit those contracts,” Whitesides says. “I was at the mercy of the market with no ability to get in or out based on ETrade’s system.”

When he complained to ETrade, the brokerage was unsympathetic. ETrade “has determined that there was not enough liquidity in the market to support exiting the position you maintained in your account,” the company said in a May 26 letter to a lawyer representing Whitesides. “Accordingly, ETrade will not be making any adjustments to your account.” Brett Goodman, ETrade’s chief business development officer, didn’t respond to several phone calls and emails seeking comment.

The same thing happened to a trader on TD Ameritrade. The loss there was $92,000 for three contracts bought for about $21 each that day, according to the trader, who asked not to be named for fear of reprisal. When he tried to sell, TD Ameritrade’s system rejected his attempts, saying it couldn’t process negative prices. The trader says a TD Ameritrade representative told him two days later that operations on the exchange where oil is bought and sold worked perfectly and that he should have used a market order, which allows for a sale at the current price, rather than a limit order, which specifies a minimum selling price.

Most of TD Ameritrade’s clients weren’t trading oil that day, spokeswoman Becky Niiya said in an e-mailed statement. The brokerage counts 12 million customer accounts, where a single person can hold more than one account, she said. Niiya declined to comment when asked if the brokerage would reimburse its customers for the technical breakdown.

Mike Gatto, a partner at Los Angeles-based law firm Actium LLP, says he’s been contacted by three ETrade customers with big losses. “The way that day unfolded has mortified traders who have come to rely on ETrade’s execution guarantees, because that day trades simply weren’t executed,” Gatto says. His firm is working with other attorneys and may take legal action to recover losses. “When you buy a car, you expect to be able to accelerate—and brake,” he says. “When you use a brokerage, you expect to be able to buy—and sell.”
 
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