If an investor wants delta exposure to $50,000 of IBM stock on March 27th, 2013 has several options to acquire the exposure:
Funding the entire position from savings
- Customer pulls money from money market account, forgoing interest at 0.48% annually or $240
- Customer loses flexibility to use that cash for other purposes
Funding the position with $25,000 cash and $25,000 margin loan
- Customer pulls $25,000 from money market account, forgoing interest at 0.48% annually or $120
- Broker charges 8% annually or $2,000 for the $25,000 margin loan
Investor uses Single Stock Futures
- The customer buys the IBM SSF (stock + interest) with an embedded interest rate of 75 basis points or 0.75%
- Interest cost is $375 annually
- Customer uses treasury bill to meet initial margin requirement with the yield continuing to accrue to his benefit
- Customer continues to earn interest on the $50,000 cash in money market account, earning 0.48% or $240 annually.
® EFP (Exchange Future for Physical) transaction but with some very important differences
- No counter party risk as all trades are cleared through the AA+ rated OCC.
- No splits of the profits
- A long stock holder, who buys an OCX.NoDivRisk EFP (buy futures, sell stock) for a hard to borrow stock, earns the
difference between the future price and the stock price; plus any interest that accrues on the proceeds from the
A sample transaction for a hard to borrow stock is detailed in the NoDivRisk EFP Presentation.
The long equity holder buys an OCX.NoDivRisk EFP (buy futures, sell stock), flattening out their stock position and creating a long OCX.NoDivRisk EFP position. The customer has full use of the proceeds from the stock sale while maintaining delta exposure through the futures position.
As of March 2013, the overnight repo rate was approximately 0.17%, the best EFP offer was 0.32%.
Idle Cash Investing
The participant buys the stock and sells the futures, thus investing the cash at the EFP rate with no exposure to the underlying price moves as the delta of the long stock is exactly equal to the delta of the short SSF. This position may be maintained by rolling forward the SSF leg. It may also be taken to expiration where the long stock position is used to satisfy the obligation of the expiring short future. It is important to remember that the long stock combined with the short SSF results in zero exposure to the underlying security movement making it a pure financing trade.
As of March 2013, average money market rates are 0.48%; the highest EFP bids were at approximately 0.68%, which is a 42% higher rate.