IB no interest on first 10K rule, what do you do with the money?

[rayl]

Quote from jimrockford:

The commissions are negligible compared to the return on EFPs.

I think it is so silly to suggest that taxes cancel the benefits of EFPs, that I won't even waste my time arguing the point.

That is true if you're only talking about 10K (I guess that IS the subject of this thread).

If you're considering using EFPs to generate incremental income on cash, the incremental is only around 50 bps if you consider IB's 10k to 100k rate. One EFP -- say it's a $50 stock (high end)... 3 months to next roll.... That's a $6.25 pre-tax incremental benefit. After tax, it's probably ~$4. Take out $0.50 commission, it's $3.50.

If you hold excess cash outside of IB, the spread is thinner still.

Personally, I am not trying to find a solution to the 10k issue as with constant trading, you'd need to keep buying/selling EFPs to provide liquidity. To me the 10k is part of the implicit cost ofusing IB.

I guess we'll agree to disagree.

PS: I'ved edited my previous post since you quoted it, bec I just remembered that code sec 1259 on constructive sales may be applicable, hence the discrepancy in my words.

 

[jimrockford]

Quote from rayl:

That is true if you're only talking about 10K (I guess that IS the subject of this thread).

If you're considering using EFPs to generate incremental income on cash, the incremental is only around 50 bps if you consider IB's 10k to 100k rate. One EFP -- say it's a $50 stock (high end)... 3 months to next roll.... That's a $6.25 pre-tax incremental benefit. After tax, it's probably ~$4. Take out $0.50 commission, it's $3.50.

If you hold excess cash outside of IB, the spread is thinner still.

Personally, I am not trying to find a solution to the 10k issue as with constant trading, you'd need to keep buying/selling EFPs to provide liquidity. To me the 10k is part of the implicit cost ofusing IB.

I guess we'll agree to disagree.

PS: I'ved edited my previous post since you quoted it, bec I just remembered that code sec 1259 on constructive sales may be applicable, hence the discrepancy in my words.

I'm not going to waste my time arguing against your suggestion that taxes cancel the benefits of EFPs, but I will simply point to a factual error you made. EFPs certainly provide far more interest than the zero interest IB pays on the first 10K in cash and the first 100K in short sale proceeds. You said that EFPs pay only about 50 basis points above the lowest tier interest rate IB pays, but in fact, if you observe quotes ovet time, you will see that EFPs often provide incremental benefits greater than 50 basis points.

 

[OldTrader]

Quote from rayl:

One other little issue is if the stock goes up, you get a short term gain, but the offset is a 60/40 loss on the regulated futures contract.... On the other hand, the implied dividend yield on the long underlying probably does not account for the preferential tax rate for dividends.

Of course if the stock goes down, this works in your favor, assuming the MTM margin requirements do not put you into a net debit position.

Just thought I'd mention that SSFs don't qualify for the 60/40 treatment on capital gains. That was one of the disadvantages of SSFs from the beginning.

OldTrader

 

[rayl]

Quote from OldTrader:

Just thought I'd mention that SSFs don't qualify for the 60/40 treatment on capital gains. That was one of the disadvantages of SSFs from the beginning.

OldTrader

Good to know. Thanks.

 

[rayl]

Quote from jimrockford:

I'm not going to waste my time arguing against your suggestion that taxes cancel the benefits of EFPs, but I will simply point to a factual error you made. EFPs certainly provide far more interest than the zero interest IB pays on the first 10K in cash and the first 100K in short sale proceeds. You said that EFPs pay only about 50 basis points above the lowest tier interest rate IB pays, but in fact, if you observe quotes ovet time, you will see that EFPs often provide incremental benefits greater than 50 basis points.

So this is useful to know -- I didn't think short credit balances can be redeployed to EFPs.

And like I said, on the straight cash & first 10k issues, we'll agree to disagree on the finer points. I certainly want what you say to be correct. If I observe a spread greater than 50 bp over money market instruments, then I will surely react (actually 25 bp in after tax/after costs advantage is what I usually want to react). But for the last week, this has not been the case yet, which is all fine as I have yet to fully study these contracts anyway.

 

[jimrockford]

Quote from rayl:

So this is useful to know -- I didn't think short credit balances can be redeployed to EFPs.

They cannot.

If you hold a short stock position, and then sell an EFP, you buy back the stock, thus eliminating the short, and you replace it with a short SSF. The SSF eventually expires, at which time it is settled by the re-establishment of your short position. You earn, in the meantime, the SSF's premium over the stock, as established at the time you sell the EFP. This premium gradually decays toward zero at the time the SSF expires.

The premium you earn, by temporarily replacing your short stock with a short EFP, represents a rate of interest determined by the market, as an alternative to IB's interest paid on short sale proceeds. IB's rate, and the rate of any other broker, is less than the market rate, so the EFP is advantageous. IB's rate is zero for the first 100K in short sale proceeds, so EFPs are extremely advantageous for shorting in small accounts.

 

[rayl]

Quote from jimrockford:

They cannot.

If you hold a short stock position, and then sell an EFP, you buy back the stock, thus eliminating the short, and you replace it with a short SSF. The SSF eventually expires, at which time it is settled by the re-establishment of your short position. You earn, in the meantime, the SSF's premium over the stock, as established at the time you sell the EFP. This premium gradually decays toward zero at the time the SSF expires.

The premium you earn, by temporarily replacing your short stock with a short EFP, represents a rate of interest determined by the market, as an alternative to IB's interest paid on short sale proceeds. IB's rate, and the rate of any other broker, is less than the market rate, so the EFP is advantageous. IB's rate is zero for the first 100K in short sale proceeds, so EFPs are extremely advantageous for shorting in small accounts.

Got it. Using a position in the future instead of the underlying. You'd probably roll the futures rather than enter EFPs in this scenario. Maybe initially use an EFP to convert the underlying position into a futures position, but then roll futures thereinafter.

I momentarily misread (optimistically!) your stmt to mean you can use net-neutral EFP positions (i.e., start from flat) to get a higher yield on short proceeds (for short sales of underlyings for which futures do not exist).

 

[stock777]

Its all starting to sink in. I think IB is dropping the ball by not giving concrete , actual examples of EFP transactions and the associated buying power / interest earned ramifications.

I called , was moved to the trade desk, and not surprisingly the rep was confounded by my fairly simple questions.

If they want people to take on new products, they have to make the transaction as transparent as possible.


jimrockford stated that if you buy an EFP for 100% of your cash, your buying power drops to approx 3-1 intraday and 1-1 overnight. So a 100k account could only buy and hold overnight 100k worth of stock (and be charged margin interest on that position). Correct?

In order to avoid overnight margin, you need to dispose of some or all of the EFP or add cash to the account.

That brings up another question. How 'expensive' is it on average to free up cash by buying back the EFP. If I'm not mistaken, it look like around .25 % spread on most of the quotes.

Not something you'd want to be doing very often at that rate.

Seems to me this is most useful for those that daytrade stocks or futures. Swing traders may find the hassle and costs more than its worth.

 

[rayl]

Quote from stock777:

Its all starting to sink in. I think IB is dropping the ball by not giving concrete , actual examples of EFP transactions and the associated buying power / interest earned ramifications.

I called , was moved to the trade desk, and not surprisingly the rep was confounded by my fairly simple questions.

If they want people to take on new products, they have to make the transaction as transparent as possible.


jimrockford stated that if you buy an EFP for 100% of your cash, your buying power drops to approx 3-1 intraday and 1-1 overnight. So a 100k account could only buy and hold overnight 100k worth of stock (and be charged margin interest on that position). Correct?

In order to avoid overnight margin, you need to dispose of some or all of the EFP or add cash to the account.

That brings up another question. How 'expensive' is it on average to free up cash by buying back the EFP. If I'm not mistaken, it look like around .25 % spread on most of the quotes.

Not something you'd want to be doing very often at that rate.

Seems to me this is most useful for those that daytrade stocks or futures. Swing traders may find the hassle and costs more than its worth.

I think this thread has become confusing because we are mixing several concepts into one thread:

1. Using EFPs as yield vehicles, WITHOUT taking a long or short position in an equity.

If you start flat (no position in underlying or corresponding SSF), you can "sell" (as IB has it set up) an EFP and you will accomplish this. In this case, you DO need 100% equity to avoid margin because you are buying the underlying!

This was the original discussion on this thread, but it got expanded (I was partially guilty of that, bec I started the debate over how much incremental yield there actually is).

2. Use an SSF position to get positional (long or short) exposure to an equity. If you start flat, then a simple buy or sell of the SSF will accomplish this, and you get much cheaper financing, more leverage, etc., etc. [esp on the short side]. However, you will need to roll your position before expiration, or at expiration, you will end up with a position in the underlying.

2a. Some people have suggested (different thread) that you just enter into another EFP after expiration. Fine, but this generates more tax events -- if there is SSF mispricing preventing a direct rollover of the SSF, then I guess you should take delivery and consider another EFP when that mispricing becomes less unfavorable.

3. Use an EFP to switch from a position in the underlying to a position in the SSF. I think this was jimrockford's example of starting from a short position, and then selling the EFP, which flattens the short position and puts you net long the SSF. In any case, you end up in case 2. Of course, your financing costs decrease here bec. you are switching to case 2.

 

[jimrockford]

Quote from stock777:

Its all starting to sink in. I think IB is dropping the ball by not giving concrete , actual examples of EFP transactions and the associated buying power / interest earned ramifications.

I called , was moved to the trade desk, and not surprisingly the rep was confounded by my fairly simple questions.

If they want people to take on new products, they have to make the transaction as transparent as possible.


jimrockford stated that if you buy an EFP for 100% of your cash, your buying power drops to approx 3-1 intraday and 1-1 overnight. So a 100k account could only buy and hold overnight 100k worth of stock (and be charged margin interest on that position). Correct?

In order to avoid overnight margin, you need to dispose of some or all of the EFP or add cash to the account.

That brings up another question. How 'expensive' is it on average to free up cash by buying back the EFP. If I'm not mistaken, it look like around .25 % spread on most of the quotes.

Not something you'd want to be doing very often at that rate.

Seems to me this is most useful for those that daytrade stocks or futures. Swing traders may find the hassle and costs more than its worth.

IB does give examples of specific EFP scenarios on its website.

Your scenario states that you purchased EFPs in order to invest your cash. You don't buy EFPs to earn interest on cash. You sell EFPs in order to earn interest on your cash. If you have 100K in your account, and you sell 100K of EFPs, then any further overnite holds would be limited to an additional 100K (beyond the EFPs), and you would be charged margin interest on this additional stock, to the extent that it is long stock. If you wanted to avoid paying margin interest, then you would need to buy back some EFPs, or add cash to your account.

If the bid-ask spread on an EFP is 0.25%, expressed in terms of an annualized interest rate, this does not mean that a round trip costs you 0.25%. If the EFP expires in one month, then a round trip only costs you 0.25%/12 = 0.0208% plus $1 in commissions. If the EFP expires in three months, then a round trip only costs you 0.25%/4 = 0.0625% plus 1$ in commissions.

If a swing trader does not fully leverage his account, then EFPs are advantageous as a means to earn interest on free cash. If he does fully leverage his account, then he has no free cash capable of generating interest. It seems like a hassle, that costs more than what it is worth, only because you don't have a good working understanding. If you have a good working understanding, then EFPs become simple and easy. The question is whether you think it is worthwhile to invest in your own education, so that you can improve your return on capital.