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The special challenges of project management under fixed-price contracts
Lowden, George | Thornton, John
How to cite this article:
George Lowden, PMP, PgMP
John Thornton, PMP
Performing a project under a fixed-price contract is more risky than other projects. For example, the cost of such a project, agreed to with the buyer, typically is not subject to any adjustments based on the seller’s subsequent costs incurred in performing the work. Fortunately, many of the risks inherent in managing a fixed-price project can be mitigated—during development of your proposal, contracting, and executing the project.
This introductory-level paper first explains what a fixed-price project is and how it differs from other projects. Then, practical and straightforward advice is offered for how to effectively manage fixed-price projects, with a focus on addressing the special challenges, additional risks, and other pitfalls that often accompany such projects.
Managing a fixed-price project is three parts knowledge, two parts experience, and one part art. Fixed-price projects have a higher risk/reward profile. They pose greater risks in exchange for more reward—if the proposal is bid properly, the work is well managed, and changes are processed as contract modifications. You may need a little finesse to remind your client (the buyer or customer) that a change you are being asked to perform is out of scope and requires a contract modification. You also need a project team that understands the nature of fixed-price work. This section provides an overview of the fixed-price environment and how these projects differ from other projects.
Importantly, in a project being performed under a fixed-price contract, your client is buying a defined set of services for a set price. If completing the scope of work and producing the deliverables takes more effort or otherwise costs more than you, as supplier (the seller or services provider) budgeted, the client will not pay any more. The risk of incurring additional costs to complete performance of the project falls entirely on the supplier. You must continue working until the project scope and deliverables are accomplished and accepted; otherwise, you may be in breach of the contract.
In general, only when the client changes the defined scope of work can the supplier expect to receive additional funding under a fixed-price contract. Performing any out of scope work that has not been agreed to, such as through a change order process, adds costs to your project. Accordingly, managers of fixed-price projects refer to their contract as often as needed to help stay in scope with all work.
There are a number of different types of fixed-price contracts, including those that may provide for an incentive/award fee based on achieving defined performance criteria or an economic price adjustment based on changed conditions, such as inflation (PMI, 2020, p. 541). For purposes of this paper, we will refer to the most common type: a firm-fixed-price contract, sometimes referred to as an “FFP” contract. A firm-fixed-price contract is defined as: “A type of fixed price contract where the buyer pays the seller a set amount (as defined by the contract), regardless of the seller’s costs” (PMI, 2020, p. 540). Under this type of fixed-price contract, there are no adjustments to the price paid based on the supplier’s cost experience in performing the project.
Projects also may be performed for clients under two other general types of contracts:
- Time-and-material (T&M) contracts—These provide the client with the ability to acquire services or products on the basis of hourly rates listed in the contract and materials, as applicable, sometimes with a materials handling charge. If the project takes more time, effort, or cost to complete than originally assumed in the contract, the supplier performing the project is not obligated to continue working once it has expended the budget or ceiling. The risk of additional time and costs generally falls on the client. This type of contract is appropriate when the scope is less well-defined or could change during the course of the project.
- Cost-based contracts—Also referred to as cost-reimbursement contracts, these provide payment of allowable incurred (actual) costs to the extent prescribed in the contract. These contracts establish a total cost estimate for the purpose of obligating funds and establishing a ceiling. In cost-based contracts, the client carries more of the risk, as the supplier delivers “best efforts” to meet the contract requirements. Cost-based contracts often are used where the precise specifications cannot be articulated.
As shown in Exhibit 1, fixed-price contracts are the highest risk to the supplier and the lowest risk to the client (Gray and Larson, 2020, p. 453). Cost-based contracts, on the other hand, are the highest risk to the client and lowest risk to the supplier. Hence, project management discipline is particularly important for fixed-price contracts.
Exhibit 1: Contract risk.
How Should I Manage a Fixed-Price Project?
To be successful at fixed-price work, it is incumbent on project managers to employ as much project management rigor and discipline as possible, more than on T&M or cost-based work. The kind of discipline that you need to follow on fixed-price contracts includes:
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- Define your scope—Work jointly with your client to develop the project scope, objectives, and deliverables. Ensure that your scope of work, basis of estimate, or equivalent contract document defines clearly (preferably with specific, objective, and attainable criteria, as well as any assumptions) what constitutes the completed and accepted deliverables. You may have heard of such completion criteria often referred to as the “Definition of Done” in software development. Endeavor not to leave any of the scope of work vague, open ended, or subject to interpretation.
- Develop a work breakdown structure (WBS)—As you know, a WBS is a hierarchical decomposition of the work, helping you to see both the individual components and the totality of the work. The WBS subdivides the project into its various deliverables, then into smaller, more manageable, and discrete pieces of work within each descending level of the WBS, representing an increasingly detailed definition of the project work. You want to ensure that your team’s efforts are properly focused on the work required to complete the deliverables specified or otherwise needed to perform the project’s scope, not on other activities.
- Use a project schedule—This step involves determining the durations for each of the activities identified in the WBS and sequencing the activities in a logical order. Some activities likely will be performed sequentially and some performed in parallel. Project managers may be uncertain about how much detail should be included in the schedule for a fixed-price project. The level of detail is driven by the size, complexity, and risk of the project. The level of detail should be balanced so that it provides sufficient information to allow management control, but not so much detail that it becomes too cumbersome to use, review, and update.
- Manage to scope—Carefully and tightly manage your fixed-price project to ensure that you do not incur unnecessary costs (no “gold plating”) and that the work performed either is within the scope of work per the contract requirements and, in turn, your scope baseline and WBS, or covered by a change order approved by the client in a contract modification (no scope creep).
- Educate your project team and client—Education is needed, not just for your project team, but often for clients too. In particular, clients need to know both your and their roles and obligations (e.g., how long they have to review/approve deliverables) under the contract.
- Hold regular internal project reviews—A good method to measure progress toward completing—and controlling—the project scope is regular reviews. Reviews can facilitate your ongoing assessment that the products or services under development conform to the contract requirements and will meet the contract’s acceptance criteria.
- Obtain acceptance—Keep in mind the important need to obtain client acceptance of your deliverables, pursuant to the terms of your contract, both in writing and, ideally, on an ongoing basis throughout performance of the project. You should clearly define the criteria if the client has not, otherwise the possibility of an ambiguity exists. When you agree to perform a project on a fixed-price basis, it is not unreasonable for you to want to know exactly what you are expected to deliver. If you don’t know, you may find yourself working toward an arbitrary goal at a cost that may not have been reflected in your pricing assumptions.
How Important is Knowing the Scope of Work?
As project manager, you must understand the requirements of the contract’s scope of work as well as your associated cost assumptions. In a fixed-price contract, you are only contractually obligated to carry out the specified tasks and activities for a fixed price. You are not required to do more or do it better, faster, or differently, nor should the client be expecting you to do more or do it better, faster, or differently for the set price.
For example, a task in a fixed-price contract might be completing a detailed review of 100 field evaluations of a particular type and a checklist of the status of each of the evaluations by a given date. All of these elements are part of the scope baseline. (The scope baseline is the agreed-upon project scope statement, WBS, and the WBS dictionary, if used.) Change the number, type, or contents of the field evaluations or checklists, or the timing of the task, and then the scope has changed.
The scope is not a cost or price in this definition. It is a description of a task, subtask, activity, and/or deliverable; and reflects corresponding pricing assumptions proposed and accepted by the client. Always have a copy of the contract, price assumptions, budgets, scope baseline, and other related documents nearby. Refer often to these materials to remind yourself and your team what is in the agreed-upon baseline for your task or deliverable.
The main reasons that fixed-price projects fail are that they did not have a sufficiently clear and agreed-upon definition of the project’s work scope, or subsequent changes to work scope were not appropriately managed. You, as project manager, have a responsibility to clearly define and then manage the project work scope as well as the expectations of your client. Much of the responsibility to define the scope is in the proposal process. If it is not clear from the client’s solicitation, ask many probing questions, such as “why are we doing this project?” Keep asking the “why” questions to propel your search for the scope until you and the client agree to it.
As management expert Peter Drucker has noted: “Doing the right thing is more important than doing the thing right.” The right thing is performing the agreed-upon work scope. Be proactive in getting agreement with your client on your project’s scope and try to minimize any ambiguities. The time spent up front at project initiation will pay dividends as the project is executed. While this may seem like extra work to accomplish up front when you and your team typically just want to get started and make tangible progress on deliverables, it will pay off later by reducing the likelihood of rework.
What Type of Working Relationship Should Exist with the Client?
As always, you want your client to feel that your organization can be counted on to perform high-quality work, to be responsive to their needs, and to be easy to work with. One way to do it is to communicate often and practice active listening. Communication is critical in project management, and in the fixed-price environment, it is of utmost importance.
On fixed-price work, keep clients well informed of what you are doing to minimize the chances that you may waste effort on something they believe to be wrong or otherwise do not value. Therefore, a fixed-price contract may require more client meetings, outlines, interim drafts, and the like than other types of contracts. Use these progress meetings and working documents not only to review the status of each task and subtask, but also to obtain timely feedback, set and adjust expectations, and flesh out potential problems (before they become actual problems).
These meetings can help surface inconsistencies that sometimes develop between the project’s scope baseline and the client’s expectations, which may evolve and change as the project is underway and your client becomes aware of new information. If any of your project results may differ from expectations or may be controversial, you can also use these meetings to alert your client as soon as possible. You can go a long way in preventing your client from disagreeing or being unsatisfied or defensive if you have previewed results with him or her and answered questions in advance.
What Should I do if the Client Seems to be Asking for a Change?
Each manager of a fixed-price contract will receive input concerning what the client is requesting and expecting from a number of sources in addition to progress meetings and comments on deliverables. These sources include the client and its staff, other project staff who have contact with the client, subcontractors, and consultants that may have contact with the client, client publications, websites, and maybe even the media. To the extent that the client seems to be asking for something more or different than is in the baseline—in volume, quality, type, or schedule—the client may be asking for a change. Should the client approach one of your project team members about making a change, make sure they direct the client to you, as project manager, to follow up accordingly.
In this regard, be aware that striving to improve a deliverable often is second nature for team members. However, on a fixed-price contract, improvements often can inadvertently increase the work scope and result in unfavorable cost and/or schedule variances. You should caution the members of your project team to recognize that they all play a role in scope management and cannot agree to changes in scope without the project manager. Their good ideas for revising or changing the earlier, agreed-upon scope of a deliverable should not be implemented without the client contractually agreeing to the change.
You likely will need to set some ground rules for change management at the beginning of the project, and to resist the temptation to immediately agree with client requests for changes of scope. Keep in mind, the first response on the project may set expectations for subsequent requests. When a suggestion of change is made by the client, begin the process of informing your client of the cost, technical, and schedule impact.
Confirm that the client is requesting what you think you heard or read, preferably in writing. Then, before acting on the change, or even promising to do it, tactfully inform the client that the change must be processed, priced, and agreed to by both parties (preferably pursuant to a change control process). Believing that the task probably “has room” for the additional costs almost certainly is unacceptable. The same holds true for thinking that sufficient profits are going to be made anyway, that a management reserve can be tapped, or that you and your organization will make it up later or on the next job. On a fixed-price project, former baseball star Yogi Berra’s saying “it ain’t over ‘til it’s over” is particularly apt in terms of the profit that will be realized.
To be sure, in new programs, not surprisingly, the direction of the project evolves based on what has been learned to date. Changes can be used to improve what is being developed and implemented. Or the original scope may have been written much earlier and could be out of date. A change order can help deliver more value and benefit to the project. It’s just a matter of handling it correctly.
Each change must be in writing, priced, and signed by both parties before performance is begun. Managers from a predominantly T&M or cost-based contract background may be accustomed to accommodating changes straightaway. Certainly, your client needs to be satisfied on fixed-price work too. You should strive for long-term working relationships and not being perceived as “nickel and diming” or difficult to work with. But also keep in mind that your client did contract for a fixed-price job and should understand what he or she signed up to with such a contract.
Informing the client that what he or she has requested constitutes a change and likely will require additional funding is not punishing him or her. A key part of your job may be to educate the client about what both sides signed up for in the fixed-price contract. If even a few of your task managers start working “over” the scope baseline on some tasks or subtasks, they may not only risk overrunning the project and impacting the bottom line, but likely creating difficulty for others at your organization to deal with those clients on any fixed-price work in the future.
What is the Process for Making a Change to the Scope of Work?
The three most common reasons for a change to a fixed-price contract are:
- The initial requirements did not contain sufficient detail or clarity
- Requirements change due to new information about the needs of the project (better ideas occur as work progresses)
- Functionality for a product may not have been sufficiently identified and subsequently not built into the specifications for a system, particularly in IT projects
Once the need for change is identified, the change order process can differ substantially from contract to contract. Larger contracts may use a project management office and a formal change control process to review proposed changes and recommend whether a contract change is warranted. Smaller contracts may not have this infrastructure and instead will require coordination between the project manager and your organization’s contracts department. After defining the needs with the client, the manager must work together with the department to develop a change order and a new basis of estimate (or equivalent document for the additional scope) consistent with the client’s process.
The change order, inclusive of price adjustments is delivered to the client for review and approval. The process is designed to ensure that both the client and you, as supplier, understand and agree in advance on changes and that the contract is amended accordingly. In requesting the change, be sure to describe it as unambiguously as possible to avoid later confusion.
The proposed pricing for the change order generally will be based on the earlier price built into the contract. For example, suppose an original scope called for review of 100 field evaluations at a specified price of US$100 per review. The scope increased to include 200 reviews of field evaluations. You would submit a change order indicating the request for an additional 100 reviews at US$100 per review, unless something else changes (such as the time allowed to complete the reviews, the scope of the reviews, or the contents of the evaluations). Neither actual costs incurred, nor where you are with respect to budget normally enter into the calculation. The contract is not cost-based; there is not an opportunity to “true up” or adjust your overall budget/price on the basis of costs incurred to date in performing the contract.
If the client wants a change to the original or modified scope, you must scope the changes with as much detail as appropriate and price those changes accordingly. If, however, you do not believe that a requested change can be performed profitably or at the profit rate originally budgeted for the project, you should discuss the requested change with your supervisor. You want to maintain good relations with your customer, but you must balance this with potentially performing additional work unprofitably.
What are Some Ways to Manage and Mitigate Risks?
Risk management is important on all projects, but especially so on fixed-price projects. As you know, project risk management includes processes for conducting risk management planning, identifying risks, analyzing risks, planning risk responses, and monitoring and controlling risks (PMI, 2009, p. 4). Risks can be related to technology, scope/requirements, approach/methodology, quality, schedule, estimating/budget, staffing/resources, and other factors. Risks also can be internal, within the control of the project manager, and external, outside the control of the project manager. This well-established field in project management includes many different processes, tools, and techniques to help managers address risk.
With our focus on fixed-price projects, you should be aware that there may be a number of ways for you to transfer or reduce some of the risks that are inherent in such projects, as follows:
How are Contingency Reserves Utilized to Address Risks?
One of the important tools to address risks on fixed-price projects is through establishing reserves. A contingency reserve can be thought of as potential costs, not profit or fee, that are incorporated into your project budget, as part of the cost baseline, allocated for addressing and mitigating the specific risks that you may anticipate on the project. A contingency reserve often is referred to as addressing the known unknowns on a project (the foreseeable uncertainty or the identifiable risks). More broadly, contingency reserve is defined as: “Budget within the cost baseline or performance measurement baseline that is allocated for identified risks that are accepted and for which contingent or mitigating responses are developed” (PMI, 2020, p. 533).
Exhibit 2 depicts a typical buildup of the price for a fixed-price project, from the client’s and supplier’s standpoint. As shown, there is your expected cost of undertaking the project, which is comprised of two parts: (1) the base cost estimate; and (2) the cost associated with a contingency reserve, providing the allowance for additional activities that may be needed beyond what was assumed and planned in your base cost estimate. Fee, likewise, is comprised of two parts: (1) a management reserve, if used, to be tapped in an emergency if any unforeseen risks may occur (discussed in the next section); and (2) the fee that is appropriate for the type of project, market conditions, level of competition, strategic considerations, and other factors.
Exhibit 2: Buildup of fixed price.
In basic terms, managers set up contingency reserves—certain mitigating activities and, in turn, priced and budgeted costs—to help be prepared if (or when) specific, identified risks may occur. Including contingency reserves in your budget does not necessarily mean that the risk-related activities will be performed and the associated budget will be expended (either in part or in full), as the risk may not materialize. Instead, it means that your project (including scope, budget, and schedule) is in a state of readiness for uncertain situations that may occur. Essentially, it means that you have recognized particular risks and, in the parlance of project management, appropriately mitigated them through your advance planning.
Through the contingency reserve that you have inserted into your planning, the risk-related activities and related budget are then at your disposal if any of the uncertainties occur. The contingency reserve is there if you need it. If you are fortunate, you may not need to expend the reserve. In fact, your goal as project manager is not to use the reserve amount, if possible.
A key advantage to an organization performing fixed-price contracts for clients is that you may not need to spend your reserve. If you can successfully complete your project for less than budgeted, including not tapping reserves, then you can earn a higher profit (the untapped reserve is converted to additional profit). A client is willing to trade off this potential for your earning a higher profit on the project in return for the security of paying a predetermined, set amount to get the product or service. Fixed-price contracts also may represent less of an administrative burden to clients.
Put another way, fixed-price contracts involve greater financial risk to the supplier, as you bear the full impact of any costs that may exceed your budget estimates and price. In return for assuming this higher risk, you can realize the full benefit of any cost savings vis-à-vis your project budget and, as a result, earn a higher profit. Keep in mind, though, to earn such a profit you need to be prepared to exert a high level of project management discipline from the outset. You do not want to unnecessarily expend reserves on activities other than the identified risks that were the basis for the reserves. Another benefit of incorporating contingency reserves into your budget is that there likely will be less frequent changes needed in the budget, as you would have attempted to already include all foreseeable elements of cost.
To determine what level of contingency reserves to incorporate into a fixed-price bid, start by asking how comfortable are you in the base cost estimate being sufficient to perform the contract’s scope. If you already are knowledgeable about the type of work (both in general and as it applies to the particular project), are familiar with and have mastered any technologies or tools involved, and have favorable experience with the client and any subcontractors, then there may be less risk. In this case, you may have relatively high confidence in your base cost estimate and feel there are less risks to mitigate by separately budgeting reserves as part of your price build up.
On the other hand, and perhaps more likely, you may feel that there are some specific risks remaining that could affect your work, such as:
- Approach—There may be a risk that you have misinterpreted the contract’s statement of work or scope in some way in developing your technical approach and, thus, a possibility that your approach may have to be modified.
- Deliverables—Given the nature of a project, such as for a new client or a new and evolving program with many stakeholders, you may anticipate the risk of more rework of deliverables, above and beyond what is assumed in your base cost estimate.
- Staffing—There may be uncertainty over your project staff, such that there is a possibility that you may need different or additional resources to complete the work than you have assumed.
- Schedule—There may be a possibility that you will need more time to perform the work than you assumed in your base cost estimate, which typically leads to more staff being needed.
- Client—You may wonder if your client will be able to hold up its obligations, potentially introducing delays or other problems that may impact your project and may not have been accounted for in your base cost estimate.
Your contingency reserve is the amount set aside for risks such as these that may occur and, if so, some additional activities would need to be undertaken beyond what was included in your base cost estimate. Keep in mind that a contingency reserve is for addressing risks. It is understood that risks may or may not occur. In fact, in the building up of your fixed price, there has to be a real possibility that you may not actually need to expend the contingency reserve. If you are aware in advance that you will need to expend it, then—by definition—the amount being reserved is not associated with responding to a risk that may or may not happen. That contingency reserve amount instead belongs in your base cost estimate, not as a contingency reserve intended to mitigate a potential risk.
How are Management Reserves Utilized to Address Risks?
A management reserve serves the same general purpose as a contingency reserve—mitigating the effect of risks that may occur—but with a focus on addressing a different kind of risk: the unknown unknowns (the unforeseeable uncertainty or the unidentifiable risks). A management reserve can be thought of as an incremental amount to the planned fee on a project that may be incorporated into a project’s overall fixed price (as potential profit or fee, not costs). Given the inherent uncertainty, a management reserve often is calculated simply as a percentage (5%, 10%, or 15%, for example) of the cost of the project, to be tapped in an emergency and typically with the approval of management, the project sponsor, or a steering committee. A management reserve is broadly defined as: “An amount of the project budget withheld for management control purposes. These are budgets reserved for unforeseen work that is within scope of the project. The management reserve is not included in the performance measurement baseline” (PMI, 2020, p. 545).
There often is confusion between a management reserve and a contingency reserve. In particular, if a risk occurs on your project (an event or condition not incorporated in your base cost estimate) and needs to be addressed, do you access funding from the management reserve or contingency reserve? If a risk that you had anticipated occurs, then you utilize the contingency reserves accordingly that were put in place for such a situation to fund the needed mitigation/response activities.
If an unidentified risk occurs, the options may include: (1) addressing the situation with your client, preferably through a change order or similar process that may be available (especially if the risk is outside the scope of the project); (2) obtaining management approval to access a management reserve that may have been included as part of your project’s overall fee for this purpose; or (3) reallocating any contingency reserves that may not be needed for previously identified risks that no longer are expected to occur. Exhibit 3 outlines some of the important differences between a contingency reserve and a management reserve.
Exhibit 3: Comparison of reserves.
Project managers often address the need for reserves through a management reserve, which is much simpler and faster to develop than a contingency reserve. Or project managers may include the potential cost for dealing with risks within the WBS tasks/activities that are to be undertaken and the associated base cost estimate, rather than separately identify the risks and budget them as contingency reserves. The downside of this approach is that both you and your management will have less visibility into the risks that you may encounter, how you intend to mitigate them, and what are the associated cost impacts.
Importantly, managers should avoid using either contingency or management reserves for scope changes. Preferably, changes in scope are handled with your client through a separate change order process. Both contingency reserves and management reserves normally are intended for risks and uncertainties that may occur within the pre-existing, defined project scope. Only if, for some reason, you had anticipated a specific scope change, included it on a risk register or equivalent document, and established adequate contingency reserves to fund the mitigation/response activities associated with the expected change, would you plan to access the contingency reserves.
If you are concerned that your fixed-price quote cannot support including reserves, your best option may be to specify, as completely as possible, the assumptions that you can live with for performing the requirements at your proposed price. Attempt to bound and put sufficient parameters around your carrying out the scope, such as in your technical approach and/or basis of estimate, if applicable. In the process, remember that your proposal’s technical approach and any basis of estimate must be aligned.
What if including reserves may be perceived by your client as padding that will result in unnecessary costs or losing the bid? It is certainly not in an organization’s long-run interest to submit fixed-price quotes that are based either on including costs that cannot be supported (padding) or, alternatively, excluding costs that may be needed. By providing support and a rationale for such activities and costs in a thoughtful technical approach, basis of estimate, or equivalent document, as appropriate, your client may be more inclined to find them acceptable or be willing to discuss the assumptions with you in negotiations. In some situations, it is possible that reserves (or other funds set aside for potential scope changes) may be held—and released as needed—by the client, perhaps when you are contracting with a government agency or department.
Fixed-price contracts certainly are different from other contract types—in how risk is allocated between you and the client, how you manage project costs, how you deal with the client, even in how you treat the contract itself. The successful project manager understands the differences among contract types and employs appropriate business practices throughout the project’s life cycle.
Gray, C. F. & Larson, E. W. (2020). Project management: The managerial process (6 th ed.). New York, NY: McGraw Hill.
Project Management Institute. (2020). A guide to the project management body of knowledge (PMBOK ® guide) – Fifth edition. Newtown Square, PA: Author.
Project Management Institute. (2009). Practice standard for project risk management. Newtown Square, PA: Author.
© 2020, George Lowden & John Thornton
Originally published as a part of the 2020 PMI Global Proceedings – London, UK
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- tastyworks: Best Broker for Mobile Options Traders
- E*TRADE: Best Broker for Beginning Options Traders
- eOption: Best Broker for Low-Cost Options Trading
Best Options Trading Platform, Best for Advanced Options Trades, and Best for Mobile Options Traders: tastyworks
- AccountMinimum: $0
- Fees: $0.00 stock trades, $1.00 to open options trades $0.00 to close
Tastyworks says that more than 90% of the trades placed by its customers are derivatives, so they naturally spend their time designing a lot of tools specifically for options and futures traders. Everything is designed to help traders evaluate volatility and the probability of profit. Tastyworks’ entire platform is geared towards making decisions and taking action. Tastyworks opened its virtual doors in 2020, so it isn’t saddled with legacy systems that bog down many of the older online brokers. This has helped it tremendously in keeping the options trading experience to the essentials. Tastyworks’ executions are fast and the costs are low, with commissions capped for opening orders for options on equities and futures at $10 per leg.
Watchlists are a key component of the tastyworks platform, and they are the same on mobile, web, and download. The look and feel of the mobile platform is very similar to the desktop versions, though you’ll find price wheels and ways to define trades that minimize the possibility of making a mistake. As you build a position from a chart or from a volatility screener, a trade ticket is built for you. There’s also a video viewer embedded so you can keep an eye on the tastytrade network. Though a newcomer to options trading might be initially uncomfortable, those who understand the basic concepts will appreciate the content, features, and focus apparent throughout tastyworks’ platforms.
All of the tools you’ll need for analyzing and trading derivatives are built into the platforms.
The charting capabilities are uniquely tuned for the options trader. If you have multiple positions on a particular underlying, you can analyze the risk profiles of the combined position.
There are hours of original video from tastytrade every weekday, offering up-to-the-minute trading ideas, plus a huge library of pre-recorded videos and shows.
Newcomers to trading and investing may be overwhelmed by tastyworks at first.
There is no fixed income trading (outside of ETFs that contain bonds) for those who want to allocate some of their assets to a more conservative asset class.
Any additional portfolio analysis beyond profit and loss requires setting up a login on a separate site, The Quiet Foundation, which is also part of the tastytrade empire.
Best for Beginning Options Traders: E*TRADE
- AccountMinimum: $0
- Fees: No commission for stock/ETF trades. Options are $0.50-$0.65 per contract, depending on trading volume.
New options traders need some help in understanding how trading derivatives can help improve portfolio returns. E*TRADE’s more advanced platforms are elegantly designed and guide you along the way. When you graduate to options and derivatives, the Power E*TRADE website and mobile app can help you learn. The Power E*TRADE site and app can be set up to put the functions you use most often front and center so you don’t have to dig around for them. The platform has all the features inherited from E*TRADE’s acquisition of OptionsHouse technology, which includes a wealth of helpful educational resources for the developing options trader. Watchlists are integrated across E*TRADE’s platforms, and the full range of tradable assets is accessible on the mobile apps. The workflow is very smooth on the mobile apps. We also found that using Power E*TRADE on a tablet is quite pleasant.
Mobile apps are extremely well laid-out and easy to use and are among the most comprehensive and extensive apps tested.
Spectral Analysis on Power E*TRADE is a visually stunning tool that helps you visualize maximum profit and loss for an options strategy and understand your risk metrics
You can test strategies using the paper trading capabilities of E*TRADE Pro’s desktop platform, which uses delayed data so you won’t think you’re placing real trades.
On all platforms, you’ll find a ubiquitous trade ticket with streaming real-time data.
Tiered commission schedule for options trades, charging $0.65 per contract for less frequent traders and $0.50 for those who place more than 30 options trades per quarter.
Investors who would like direct access to international markets or to trade foreign currencies should look elsewhere.
You cannot consolidate your externally-held accounts to form a complete picture of your net worth on E*TRADE.
Best for Low-Cost Options Trading: eOption
- Account Minimum: $0
- Fees: $0 per stock/ETF trade, $1.99 base per leg plus $0.10 per contract for options trades
eOption charges $1.99 per leg for options trades, but the per-contract fee is significantly lower than its competitors, making it great for heavy options traders. eOption also offers commission-free stock and ETF trading so those who are options-oriented traders but also want access to other assets at a low cost will have no issues here. Clearing and exchange fees, typically a fraction of a penny per share, are spelled out on the order confirmation screen and are passed through to customers. eOption also scored highly for its relatively low margin rates.
eOption offers great value for frequent options traders.
The browser-based eOption Trader platform is easy to use.
Newsletter subscribers can auto-trade their alerts.
Limited education offerings.
News feeds are limited.
Any OTCBB (penny stock) trades must be made with a live broker.
Other Options Considerations
The commission structure for options trades tends to be more complicated than its equivalent for stock trades. Until the commission cuts that swept the industry in the fall of 2020, most brokers charged a fee for each leg of an options spread plus a commission per contract being traded. The per-leg fees, which made 2- and 4-legged spreads expensive, have been eliminated industry-wide, for the most part. We are also seeing some brokers place caps on commissions charged for certain trading scenarios.
Investors with fairly large portfolios can also take advantage of portfolio margining at some brokers. This is a practice that assesses the total risk inherent in a portfolio that contains stocks and derivatives. Investors with large portfolios can use portfolio margining to reduce the size of the margin loan.
What Kind of Options Trader Are You?
The first and most important piece of information to consider before selecting an options trading account is what kind of trader you are. What is your trading style and risk appetite? Which tools would you like to have handy?
Options are complex products to understand and trade. All of the brokers listed above allow customers to build complex options positions as a single order. Some brokers, such as Vanguard, only allow one position per order, leaving it to the individual trader to place multiple orders one at a time to create a combination position. Merrill Edge lets you place two-legged spreads, but anything more complex will require an additional order.
If you’re just getting started with options trading, the quality of education and help offered by your broker is important. Frequent traders and those who trade a large number of contracts will be more sensitive to commissions and fees, so check out your prospective broker’s charges and make sure you understand them.
Investopedia is dedicated to providing investors with unbiased, comprehensive reviews and ratings of online brokers. Our reviews are the result of months of evaluating all aspects of an online broker’s platform, including the user experience, the quality of trade executions, the products available on its platforms, costs and fees, security, the mobile experience and customer service. We established a rating scale based on our criteria, collecting thousands of data points that we weighed into our star-scoring system.
In addition, every broker we surveyed was required to fill out an extensive survey about all aspects of its platform that we used in our testing. Many of the online brokers we evaluated provided us with in-person demonstrations of its platforms at our offices.
Our best options brokers have a wealth of tools that help you measure and manage risk as you determine which trades to place. These brokers include valuable education that helps you grow in sophistication as an options trader. Investors with fairly large portfolios can take advantage of portfolio margining at certain brokers, a practice that assesses the total risk inherent in a portfolio that contains stocks and derivatives, and can reduce the size of your margin loan.
Our team of industry experts, led by Theresa W. Carey, conducted our reviews and developed this best-in-industry methodology for ranking online investing platforms for users at all levels. Click here to read our full methodology.
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