fact that a seasoned, knowledgeable professional who understands your risk better than you do is watching your back.
Of course, there are other considerations. One brokerage firm I have dealt with has a very quick “trigger finger” and will cover your risk for you without even a single phone call. Though this is preferable to not calling at all, it can subject you to losses you might not need to incur. There is a commonsense balance I want my brokerage risk managers to maintain. I want them to let me know when my risk is too large, but I want to have the opportunity to cover my own risk, providing I do so quickly.
Previously, I mentioned that brokerages are not insured against trading losses or fraud. We have had two recent examples of this, and they have shaken the faith of some investors with respect to brokerages. First, there was the bankruptcy of MF Global on October 31, 2011. MF Global was known in the trading world as a large futures clearing firm, though it had a multifaceted business. Ultimately, MF Global violated the segregation of funds law we discussed earlier and dipped into customer funds to cover its own obligations. What led to their shortfall? Purportedly, they had lost hundreds of millions of dollars purchasing sovereign debt from some of the countries mired in the European debt crisis (Spain, Italy, Portugal, Belgium, and Ireland). So, not only are you not insured against your own losses, but also you are not insured against losses incurred by your brokerage firm. This is why I stress getting a firm with deep pockets and good trading (and enterprise) risk management experience and procedures. Ultimately, investors recouped around 93 percent of their money from the firm.
On July 10, 2012, Peregrine Financial (also known as PFGBest) filed for bankruptcy. Unlike MF Global, Peregrine went bankrupt for a much more nefarious reason. Their CEO, Russell R. Wasendorf Sr., admitted to embezzling money from customer accounts over a period of 20 years. How did he get away with it for so long? He became very adept at forging bank statements, and he set up a false address for a bank so that NFA (National Futures Association) regulators thought they were receiving “proof” of his accounts. In truth, he was forging inflated bank statements to hide his embezzlement and was fraudulently creating false statements on a daily basis for regulators. For his efforts, after a failed suicide attempt and a guilty plea, Wasendorf received a 50-year jail sentence, the maximum allowed by law.
Once again, my goal here is not to frighten you, but rather to make you aware that you need to do your due diligence when choosing a brokerage firm. Fortunately, with each “failure,” regulators learn more and become more adept at their jobs. Personally, I have not lost one second of sleep about the safety of my funds in the brokerages with which I currently have accounts.
Though there are various ways to break down account types, I will stick with the three types that are applicable to options trading. So, for our purposes, we will categorize accounts as the following:
1. Cash
2. Reg-T Margin
3. Portfolio Margin
Cash Accounts
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