Single Stock Futures Anomolies
IN the following TMF post, David G. Downey, CEO of OneChicago shed light on why the SHLD SSF was trading below fair value. A topic brought up by a excellent TMF poster. I’m reposting it here as it is an interesting piece of information which was buried in a thread on Toyota.
It is true that in a positive interest rate and positive time environment that the SSF should trade at a positive basis to the the stock since there is no dividend. But in certain cases there is another pressure at work and it is called Stock Loan.
Certain stocks are difficult to borrow. When short sellers want to go short they need to borrow the stock. In return they put up 102% of the value in cash which gets reinvested by the lender’s agent and the proceeds from this reinvestment are split between the lender, the agent, the brokerage firm and in some cases the short seller. This split to the borrower is called the Rebate Rate.
Some stocks are very difficult to borrow as I mentioned so in addition to the 102% collateral the brokerage charges an additional commission called a Negative Rebate. SHLD happens to have a negative rebate that exceeds 32%/yr. Accordingly people who are involved in the process would like to get long SHLD so they can loan it out for the Rebate but they don’t necessarily want to take the SHLD market exposure. They offer the futures at a steep discount and if someone buys the SSF the seller is now short delta and immediately buys the stock. The resulting position is delta neutral as the stock and SSF move in tandem with each other. The market maker then loans the stock out and collects the negative rebate which acts to reduce the net purchase price of the stock below where he sold the future.
For customers who are contemplating buying SHLD as an investment they should consider purchasing the SSF now and at expiration they collect the stock as the SSF expires but they will be buying the position at a much lower price.
For customers who are currently long SHLD they should consider using an Exchange for Physical (EFP) transaction whereby they simiultaneously buy the SSF and Sell the stock. The resulting position has the same delta exposure but at lower net price. In addition the SSF requires a 20% margin which could be met with an interest earning T-Bill and you free up the bulk of your capital that was used to purchase the stock outright.
via TMF: Tokyo Industries F/U / Falling Knives .
The other thing to consider by those holding SHLD or contemplating buying is why are the shorts willing to pay so much over fair value to go short?
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