Here is another example of something to watch when trading EFPs. This morning, IB's market scanner for high-paying EFP shorts quoted a sky-high, annualized interest rate of about 6% on the December EFP for MYL. This calculation is based on the assumption that MYL will be paying a 6 cent dividend prior to this December expiration; mouse-over the TWS Dividends field for details. Think this is a bargain? Think again. MYL, in reality, recently voted to suspend its dividend. So you won't be earning 6% by shorting MYL's December EFP. IB's dividends data are only given on a "best guess" basis. It is your responsibility to verify the dividends info. You can update the dividends info in your own TWS, by using the Edit Dividends feature. If you do this, you will see that the December EFP on MYL actually pays only 5.25%, which is not competitive with higher rates available from other EFPs. IB hasn't yet updated its dividend info for MYL. You can address the risk that a dividend might be reduced or cancelled, after you short an EFP, if you either avoid EFPs which depend on dividends prior to expiry, or if you are particularly knowledgeable about a particular company, so that you are willing to make a bet about what will happen to dividends prior to expiry.
The dividends editor issue is quite tricky in general (for options pricing as well).... I forget the underlying but on Tue there was something showing a 9% imputed yield on EFP bec the dividend on the preferred was added into that of the common.
So, the yield is only 100% accurate if the stock doesnt pay dividend, correct? If u are already shorting a EFP on a non-dividend paying stock, all u are left with is a surprise dividend.
A surprise dividend on a short EFP works in your favor. You are long the stock leg of a short EFP, and so you receive the dividend. If truly a surprise, then such a dividend provides you with a return above the normal market rate of interest. The yield quoted by TWS is 100% accurate, but only if the dividend is 100% accurate. The dividend is 100% accurate most of the time, and 0% accurate the rest of the time. If you are shorting an EFP with an expected dividend, you need to do your homework. If you are longing any EFP, you must do your homework in order to avoid responsibility for paying any surprise dividend, which might increase your financing costs above the market rate. You generally need to protect yourself, not only from surprise dividends, but from inaccuracies and omissions and errors in IB's dividends database. The database provides a starting point, not a substitute, for your homework as a trader.
so what are the risks with EFP's? a) suprise dividends/changing dividends b) changing interest rates c) ? Is a potential strategy to borrow money via long EFP @ a low rate and then use it to short higher yield EFP's? - mnx
No, not under present IB policies, if I correctly understand the examples on margin interest given on IB's website. The proceeds from the short stock leg of a long EFP, are treated, by IB, like the proceeds from any other short sale of stock. IB will not allow these cash proceeds to reduce the margin interest charged on any long positions. So if you try to finance some short high yield EFPs, with funds obtained by longing lower yield EFPs, IB will charge you margin interest on the long stock legs of your short EFPs. If you have some settled cash in your account, then this will reduce the amount of margin interest charged, but to the extent such cash is used to cover your long stock, you will not earn interest on that cash. The result will be that your long EFPs will not allow you to reduce the cost of financing short EFPs, or any other position. IB could change this policy if it chose to do so. Perhaps this would be a good idea. Or maybe there are reasons not known to me, as to why such a change would be unreasonable.
Too bad the #s today weren't better or I would say -- if only a bit more investment in cust svc and it'd be near perfect....
In that case why would someone buy an EFP in an IB account? (I thought the whole point of a long EFP was to 'borrow' cash at a cheaper rate)? - mnx
Buying an EFP is cheaper than holding onto the short position as you get more interest than you would normally on proceeds from short sale.