What's this?

LeonPhelps · Jun 23, 2007

Is this some sort of scam, or what?

June 22, 2007

Dear Customer:

Our primary objective is to provide you with access to products, systems and trading tools at prices that give you a competitive advantage over other market participants.

With that in mind, I would like to provide you with some information about Single-Stock Futures and Exchange-For-Physical (âEFPâ) trading. As described below, Single-Stock Futures and EFPs can be used to:

Reduce the margin costs you pay on long stock positions
Improve your return on short stock positions
Improve the yield you receive on extra cash sitting in your account
If you start using Single Stock Futures and EFPs to improve your returns, IB will earn less on interest charges from your account. But we think youâll be a happier customer and that your profits (and IBâs) will be greater in the long run.

Depending on your degree of familiarity with the futures markets, you may find the following to be somewhat complicated, but reading it and understanding it may make you a more successful investor. It is well worth the effort.

What Are Single-Stock Futures?
Similar to stock index futures such as the S&P 500 futures, Single-Stock Futures are futures contracts on specific stocks that expire and deliver stock, on dates that coincide with the securities options marketâs expiration dates.

As with any futures contract, there is a buyer for every seller and there is a short position for every long position. The Options Clearing Corporation acts as the clearing house and holds the opposite side of each position, collecting initial margin -- in this case 20% of the value of the single stock future. Your broker requires margin collateral for the position and puts up this margin at the Options Clearing Corporation in the form of treasury bills and receives interest back from the clearing house on this collateral. Interactive Brokers and some other firms will pass the interest they receive on your futures margin deposits right back to you.

On each trading day after a Single-Stock Futures position is established, if the underlying stock goes up, the clearing house collects from the short and pays to the long for the change in the value of the contract. If the stock goes down, the clearing house collects from the long and pays to the short. Upon liquidation of the contract, the customer will be credited for profits and debited for losses.

On expiration day, the short delivers to the long 100 shares for each long contract (similar to when a call option is exercised and the seller of the short call option must deliver 100 shares to the holder of the call). These deliveries are done automatically by your broker. If you are on the short side and do not have the shares in your account, you will become short the shares. Many brokers charge a fee or a commission for this service. Interactive Brokers does not.

Single-Stock Futures usually trade at a premium to the stock price, reflecting the carrying cost of the stock, which is equal to interest less dividends. An exception to this is when there is some other advantage to having the actual stock in hand, such as a certain corporate action or when a stock is difficult to borrow.

What Is an EFP?
An Exchange-for Physicals (âEFPâ) is a type of transaction that first arose in the commodities markets -- where two parties would swap a quantity of a physical commodity (e.g., grain) in exchange for a futures contract for an equal amount of that commodity.

EFPs can also be done for Single-Stock Futures, so you can exchange stock for a Single-Stock Futures contract covering the same amount of stock. These transactions are offered on OneChicago (the Single Stock Futures Exchange).

Why Would You Use Them?
Let us examine three situations, at least one of which is very likely to apply to you at this moment:

1. You Are Long Stock On Margin And Would Like To Reduce Your Financing Rate

Interactive Brokers is extending a margin loan against your long position and charging you between 0.15% and 1.5% over the LIBOR benchmark rate (5.307% as of 06/14/07), depending on the size of your account. With an EFP transaction you can reduce this financing expense:

You can sell the stock and buy the future, say for September or December delivery.
You can do this as one transaction.
You can put your order in as a limit order, either in absolute or in percentage terms.
You can put the order in at 5.35% or even try for a lower rate -- say 5.21% -- and if your order is hit you will be financing your long position slightly over or possibly under the benchmark rate.
2. You Are Short Stock And Would Like To Increase Your Return

The situation is equally compelling if you are carrying a short stock position. On an ordinary short stock position, Interactive Brokers pays you a short rebate which represents interest on the proceeds of your short sale in excess of $100,000. These proceeds may not be withdrawn as they serve as collateral against your obligation to cover the short position, and in addition you must also post margin.

The short interest rebate paid by Interactive Brokers is 1.25% to 0.15% less than the LIBOR benchmark, provided that the stock is freely available to short (If the stock is difficult to borrow, the discount to the benchmark rate is greater and in some cases may exceed the benchmark so that the holder of the short position may have to pay the lender of the stock).

In any event, the holder of a short position could generate greater returns by buying back the short stock and simultaneously selling the Single-Stock Futures contract on that stock at a rebate rate that is higher than what is being paid by the broker on the short proceeds. Through this type of EFP, the trader maintains his market position but increases his return.

3. You Want to Receive a Greater Return on Excess Cash in Your Account

EFPs involving Single-Stock Futures can also help you simply receive a better return on unused cash sitting in your account.

If you have excess cash in your account, Interactive Brokers will pay you interest on the cash balance over $10,000, at a rate between 0.15% and 0.50% less than the benchmark rate. As of 06/14/07, that would be 5.157% to 4.807%. You could increase your return on this cash through an EFP -- offering to buy a stock and simultaneously selling it forward (using a Single Stock Futures contract) at say 5.21%.

Since you are buying the stock and selling the stock future, under normal market conditions, you are not assuming market risk on that stock, and indeed you do not even care about which stock you buy and sell forward. Just as in a repo transaction, what you are really doing here is financing somebody else's position on a fully secured basis and generating for yourself a better interest rate on your money than you would get if it that cash simply sat in your account.
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LeonPhelps · Jun 23, 2007

Caveats:
Commissions: There is a 50 cent commission you have to pay for each 100 share EFP transaction. You should deduct this amount when you are calculating your interest.
Commitment: If you have used your free cash to generate interest through a stock EFP, or if you have switched your long or short stock position into a futures contract, it is not immediately available to you to trade or invest. You can however, simply unwind the original EFP transaction if you wish to change your investment strategy.
Margin: The holder of a Single-Stock Future has to post margin for each contract. When you are utilizing an EFP to replace a long or short stock position with a Single Stock Future, your initial margin requirement will be 20% (less than the margin required for a stock position) and Interactive Brokers will credit you with interest on the margin amount. When holding an EFP to earn money on your excess cash, you will be charged the standard Reg T margin and a maintenance margin of 5% on the stock. For those customers with Portfolio Margin, the initial and maintenance margin requirements for holding an EFP position will be negligible.
Dividend: The holder of a Single-Stock Futures contract is not entitled to dividends or other benefits that accrue to the holder of record for a stock. The dividend is usually figured into the forward rate (i.e., the forward price is usually lower than it otherwise would be, by approximately as much as the dividend). However, if there is a surprise increase or special dividend announced, the person who is financing anotherâs long position by holding the stock against a short Single-Stock Future may receive a windfall benefit while the person who sold the stock and purchased the Single-Stock Future may forego the dividend.
Stock Lend and Borrow Rates: Investors who need to liquidate a long SSF position before expiration are exposed to the risk of the value of the SSF declining relative to the stock price if the stock becomes difficult to borrow.
Risk: Security futures involve a high degree of risk and are not suitable for all investors. As with any investment, there may be times that you cannot liquidate a position due to limited liquidity in the marketplace and you may be subject to substantial loss. The amount you may lose may be greater than your initial investment. Before trading security futures, please read the Security Futures Risk Disclosure Statement. For a copy, call (203) 618-5800.
I hope the above has awakened your interest in Single-Stock Futures and EFPs. Please look at our Options Intelligence Report that screens for the highest and lowest rate EFPs.

Also there is more to read about this topic on our website at www.interactivebrokers.com/EFP, or One Chicago's website at www.onechicago.com.

In the future we are going to augment the Trader Workstation with a "Relevant Single-Stock Futures" button. This will activate a screen showing you EFP rates for any stock you may be long or short and the highest available EFP rates if you have unused cash in your account. It will also show rates at which you might roll already existing Single-Stock Futures positions forward.

Have a prosperous summer.

Sincerely yours,

Thomas Peterffy
CEO
Interactive Brokers Group, Inc.
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OldTrader · Jun 23, 2007

I can only assume that since you are wondering if this is a "scam", that you are incapable of reading. Try reading it real slow, once more. It explains everything you want to know.

OldTrader

Lucrum · Jun 23, 2007

My take on it was that IB is simply trying to introduce it's customers to EFP's and SSF's.

showyouwang · Jun 23, 2007

Considering the SSFs move with their underlying, it is more return for the same risk over a long time frame because you reduce margin interest or if you are short, short interest. Theoretically the positions are about the same otherwise. Anyways, it's all explained in the email and OldTrader was only trying to offer a suggestion.

People on here are so defensive and emotional. I hope none of you guys trade like that.

atticus · Jun 23, 2007

It's not a scam; in fact, it will reduce IB's float-income if implemented by clients. An EFP or conversion arb will beat IB's interest payments by 5 to 40 basis, based upon prevailing spreads. IB gains nothing from a client trading a rate arb.

LeonPhelps · Jun 23, 2007

Quote from atticus:

It's not a scam; in fact, it will reduce IB's float-income if implemented by clients. An EFP or conversion arb will beat IB's interest payments by 5 to 40 basis, based upon prevailing spreads. IB gains nothing from a client trading a rate arb.
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Agreed. That's why I'm trying to figure out what is their angle.

tiddlywinks · Jun 23, 2007

Quote from LeonPhelps:

Agreed. That's why I'm trying to figure out what is their angle.
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The angle, very simple --
http://www.interactivebrokers.com/en/general/about/mediaRelations/03-16-06.php?ib_entity=jp

atticus · Jun 23, 2007

Quote from LeonPhelps:

You must not be part of an Italian family.

You may be right, though. Goombahs probably don't make too good of traders.
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Huh? They represent a disproportionate % of ibank traders.

trader225 · Jun 23, 2007

Bottom line: the commisions are more valuable to IB than the interest.