Why does a long SSF typically trade at a premium to the underlying stock?

Overview: 

 

Single Stock Futures will typically trade at a premium to the stock price because of an adjustment for interest rates. The premium reflects the interest earned on the capital saved by not posting the full value of the underlying stock (adjusted for any dividends expected to be received prior to expiration).

How are SSFs priced?

Overview: 

 

Single Stock Futures (SSF) may be priced using the following formula:

 

Futures Price = Stock Price * (1 + (Annualized Interest Rate * Days to Expiration/365)) – Present Value of Dividends due prior to expiration.

 

Example: On 12/12/07 MSFT closed at $35.31 and has an expected dividend of $0.11 with an ex-date of 2/12/07 (61 days).  Assuming an interest rate factor of 4.5%, what is the 12/12/07 settlement price for the MSFT March 2008 SSF (97 days to maturity)?

 

$35.62 = $35.31 * (1 + (.045 * 97/365)) – ($0.11/(1 + (.045 * 61/365)))

Is a US Single Stock Future a security or commodity product?

Overview: 

 

US Single tock Futures (SSF) are a hybrid product, regulated jointly by the SEC and CFTC and allowed to be carried in either a securities account or commodities account.  IB elects to carry all SSFs in the security side of the universal account as this is the only way that margin offset can be provided against other security products (i.e., stock, options). 

US SSFs are listed at the OneChicago exchange and are cleared through OCC.

What happens to a single stock future EFP at contract expiration?

Overview: 

 

In the case of an EFP purchase, one can let the long futures contract expire and take delivery of the long stock position at expiration, roll the futures contract prior to expiration or close the contract prior to expiration.

 

In the case of an EFP sale, one can let the short futures contract expire and take delivery of the short stock position at expiration, roll the futures contract prior to expiration or close the contract prior to expiration.

Are there any particular risks that one should be aware of when using SSFs to either invest excess funds or borrow funds at available synthetic rates?

Overview: 

While the High and Low Synthetic strategies are both hedged positions, the futures leg is subject to a daily cash variation of the mark-to-market gain or loss whereas the stock leg is not (mark-to-market gain or loss is reflected in account equity but there is no cash impact until the position is closed).  If, for example, an account holds a High Synthetic position and the stock prices increases significantly, the resultant variation pay on the short futures leg may erode the account’s cash balance resulting in a debit balance which is subject to interest payments.  The net effect in this example would be to reduce and potentially erase the earnings on the High Synthetic position

Is there a benefit to using EFPs if one doesn’t have an existing long or short stock position to swap?

Overview: 

 

One can enter into an Exchange for Physical (EFP) to either invest excess funds or borrow funds at available synthetic rates. Synthetic rates are determined by taking the difference between the SSF and underlying stock and netting dividends to calculate an annualized synthetic implied interest rate over the period of the SSF.

 

High Synthetic Bid Rev Yield – represents the investment opportunity available through an EFP sale (buy stock and sell it forward at a premium higher than the interest your cash generates).

 

Low Synthetic Ask Rev Yield - represents the borrowing opportunity available through an EFP purchase (sell stock and buy it forward at a discount lower than the lending rate available).

What is a single stock future EFP?

Overview: 

 

The EFP allows for the swap of a long or short stock position for a single stock future, maintaining the same economic long or short position but at more advantageous financing rates and margin requirements.  The cost to carry interest rate implied by the single stock future’s price is generally below the rate charged to purchasers of stock who buy on margin, and greater that that provided to sellers of stock on the sale proceeds.

 

Long Stock – alternative is to buy the EFP which involves a single transaction with two legs, a long future and short stock.  The effect of the transaction is to close the long stock position with the short stock position and maintain a long futures position through expiration.  The cost of financing the long stock (margin loan rate * 75% of stock price, less any dividends received) tends to be greater than the EFP cost (EFP premium at ask over stock, plus commission, less interest earned on margin balance).

 

Short Stock – alternative is to sell the EFP which involves a single transaction with two legs, a short future and long stock.  The effect of the transaction is to close the short stock position with the long stock position and maintain a short futures position through expiration.  There is generally a cost associated with holding the stock short (dividends paid in lieu, less interest earned on 30% margin balance, less interest earned on sale proceeds, if any) as opposed to the credit earned on the EFP (EFP premium at bid over stock, plus interest earned on margin balance, less commission).

What positions are eligible for Portfolio Margining?

Overview: 

Portfolio Margining is eligible for US securities positions including stocks, ETFs, stock and index options and single stock futures.  It does not apply to US futures or futures options positions or non-US stocks, which may already be margined using an exchange approved risk based margining methodology.

Are there any qualification requirements in order to receive Portfolio Margining treatment on US securities positions and how does one request this form of margin?

Overview: 

In order to enabled for portfolio margining an account must be approved for option trading and must have at least USD 110,000 in net liquidating equity (USD 100,000 to maintain, once enabled). Account holders will also be required to acknowledge and sign the Portfolio Margin Risk Disclosure document and be bound by its terms.  

Portfolio margining may be requested through the on-line application phase (in the Account Configuration step)  or after the account has been approved. To apply once the account has already been approved, log into Account Management and select the Settings and Account Settings menu options. In the Configuration section, click the gear icon next to the words "Account Type". There you may choose the portfolio margin treatment which will initiate the approval process.  Please note that requests are subject  to review  (generally a 1-2 day process) and may be declined for  various reasons  including a  projected increase  in margin  upon upgrade  from Reg T to Portfolio Margining. 


What is SMA and how does it work?

Overview: 

SMA refers to the Special Memorandum Account, which represents neither equity nor cash, but rather a line of credit created when the market value of securities in a Reg. T margin account increase in value. Its purpose is to preserve the buying power that unrealized gains provide towards subsequent purchases which, absent this handling, could be assured only by withdrawing excess equity and depositing it at the time the subsequent purchase is made. In that sense, SMA helps to maintain a stable account value and minimize unnecessary funding transactions.

While SMA increases as the value of a security goes up, it does not decrease if the security falls in value. SMA will only decrease when securities are purchased or cash withdrawn and the only restriction with respect to its use is that the additional purchases or withdrawals do not bring the account below the maintenance margin requirement. Transactions which serve to increase SMA include cash deposits, interest income or dividends received (on a dollar for dollar basis) or security sales (50% of the net proceeds). It’s important to note that the SMA balance represents an aggregation of each historical bookkeeping entry impacting its level starting from the time the account was opened. Given the length of time and volume of entries this typically encompasses, reconciling the current level of SMA from daily activity statements, while feasible, is impractical. 

To illustrate how SMA operates, assume an account holder deposits $5,000 and purchases $10,000 of securities having a loan value of 50% (or margin requirement equal to 1 – loan value, or 50% as well). The before and after account values would appear as follows:

Line Item
Description
Event 1 - Initial Deposit
Event 2 - Stock Purchase
A.
Cash
$5,000
($5,000)
B.
Long Stock Market Value
$0
$10,000
C.
Net Liquidating Equity/EWL* (A + B)
$5,000
$5,000
D.
Initial Margin Requirement (B * 50%)
$0
$5,000
E
Available Funds (C - D)
$5,000
$0
F.
SMA
$5,000
$0
G.
Buying Power
$10,000
$0

Next, assume that the long stock increases in value to $12,000. This $2,000 increase in market value would create SMA of $1,000, which provides the account holder the ability to either: 1) buy additional securities valued at $2,000 without depositing up additional funds and assuming a 50% margin rate; or 2) withdraw $1,000 in cash, which may be financed by increasing the debit balance if the account holds no cash. See below:

Line Item
Description
Event 2 – Stock Purchase
Event 3 - Stock Increase
A.
Cash
($5,000)
($5,000)
B.
Long Stock Market Value
$10,000
$12,000
C.
Net Liquidating Equity/EWL* (A + B)
$5,000
$7,000
D.
Initial Margin Requirement (B * 50%)
$5,000
$6,000
E
Available Funds (C - D)
$0
$1,000
F.
SMA
$0
$1,000
G.
Buying Power
$0
$2,000

*EWL represents equity with loan value which, in this example, equals net liquidating equity.

Finally, note that SMA is a Reg. T concept used to evaluate whether securities accounts carried by IB LLC are in compliance with overnight initial margin requirements and it is not used to determine compliance with maintenance margin requirements on either an intraday or overnight basis. It is also not used to determine whether commodities accounts are margin compliant. Similarly, accounts which report negative SMA at the time each day when overnight, or Reg.T initial margin requirements go into effect (15:50 ET) are subject to position liquidations to ensure margin compliance.

 

 

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