The Problem

Trading costs for stocks come in the form of commissions, execution cost, and financing costs. A great deal of attention is paid to commissions which are explicit, and with the advent of smart routers, more attention is being paid to execution cost. But despite the fact that most trade cost comes from financing charges or lack of interest paid, little attention is focused on financing rates because they are not transparent.

 

The Solution

An Exchange for Physical (EFP) is the simultaneous selling of a stock and buying of a Single Stock Future or the buying of a stock and the selling of a Single Stock Future. It allows the swap of a long or short stock position for a Single Stock Future (SSF). SSFs have an interest rate built into their price that is determined competitively by numerous market participants. Like Repos and Reverse Repos in the debt markets, EFPs provide a cheap and efficient financing vehicle. The EFP transaction is one where you sell the stock and buy it back for future delivery by buying the SSF future, or you buy the stock and sell the SSF. You do the two legs as one transaction via an EFP.

 

Taking Advantage of EFPs

The default display for EFPs is the stock vs. Single Stock Future spread. EFPs can also be displayed as an implied annual interest rate percentage, which can be directly compared to broker interest rates. This direct comparison is achieved by netting dividends and annualizing the EFP spread.

All SSFs are settled through the Options Clearing Corporation, an AAA rated entity, making any interest earned through implied interest safer than with many other interest earning alternatives. IB displays the EFP spread on an annualized basis net of dividends for easy comparison with broker interest rates.

To display implied annual interest rates or implied compounded annual interest rates, right-click the top of the bid or ask price column and choose Display EFP prices as annualized interest rate or Display EFP prices as continuously compounded interest rate. EFPs may then be bought or sold by clicking the interest rate bid or ask price. To swap a long stock position for a long SSF, click the Ask price. To swap a short stock position for a short SSF, click the Bid price. EFPs may be added to the main trading window by entering a symbol and then choosing Combinations and then EFP (smart or directed) as the asset type. They may also be added to the SpreadTrader by typing a symbol and selecting Show EFP for XXX.

The top twenty EFP highest and lowest implied interest rates may also be displayed in the market scanners to highlight interest rate opportunities. To access these scans, choose US EFP, Highest or Lowest Synthetic Interest in the Market Scanner window.

 

Any stock, options or futures symbols displayed are for illustrative purposes only and are not intended to portray a recommendation. Supporting documentation for any claims and statistical information will be provided upon request.