Friday, January 26, 2007

The rich get richer

Watch out - ETFs and options are going to go crazy after Apr. 2. 

According to Report On Business investment writer Rob Carrick, the margin rules for hedge funds trading with IDA of Canada broker-dealers are going to change on April 2 from 50 pct margin to just 15 pct for instruments like ETF’s, which will likely add to market volatility.

Source: Bill Cara: Cara’s Daytrader Bull Board, Fri., Jan. 26, 2007, 6:54 AM


Though it will not be broadly available.

Fimat USA, LLC is the only firm currently offering these new margin levels [on certain products including broad-based indices and corresponding ETFs] to investors. However, the firm reviews customers on a case-by-case basis and requires a minimum account balance of $150,000 as well as Level 5 options approval, which includes approval to trade uncovered index option writing. Other firms will have their own rules and guidelines for allowing portfolio margining.


It's 20x leverage?

Here is a new margin rule that I believe could have the same effect on equity markets...SEC APPROVES CBOE'S NEW PORTFOLIO MARGINING RULES TO BENEFIT CUSTOMER ACCOUNTS.

If you don't want to read it, I'll sum it up for you. What is says is that your margin requirement is limited to your absolute risk when you use options. For instance if you buy 100 shares of Google at $500/share-it costs you $50,000 total-or at minimum it takes $25,000 from your account if you use margin (2:1). Currently, if you also buy 1 Google Put that expires this month and has a strike of $480, and it costs $2.00 (per share)-the put will cost you $200 ($2.00 x 100 shares). All together this total position costs $25,000+$200=$25,200 (not counting trade costs). Ok, now check out the new rule (which starts after April 2nd, by the way)-the CBOE says.... really this investor can only lose 20 points on this trade (this put is a right to sell 100 shares at $480/share and the stock is currently trading at $500/share). Therefore this whole trade should only cost the trader $2000 (20 points x 100 shares=$2000.00)+ the additional $200 that the put costs, so all in all $2, 200.00 because that is all the investor can really lose on this trade. This is incredible leverage. This would allow you to buy (in this scenario) $50,000 worth of stock with only $2,200 dollars. This is 20+ times leverage versus the current 2 times leverage. This is similar leverage to what is allowed in the futures markets. There are other implications of this as well for covered calls and spreads, but the real point that I am trying to make here is that there is a significant amount of increased buying power that will be created when this requirement begins. This effectively creates new money. And, new money is usually spent.

No comments: