Index Investing Like a Pro
February 6th, 2007 by Buck Woodford
Thomas Peterffy, founder of Timber Hill and Interactive Brokers, reminds me in this missive how important the “other half” of any investment decision can be.
The concept goes all the way back to Corporate Finance 201: Decide what to invest in, and how to finance it.
He describes a key benefit of using futures to go long the S&P: the fact that futures are traded (and thus priced) by firms with incredibly low borrowing rates, and those cheap rates are implied in the futures price. Input a borrowing rate of “Prime” — currently 8.25% — into the equation, and these futures contracts are theoretically worth more to that borrower/investor than the currently quoted price. The spread trade that’s discussed are made assuming the lower (Eurodollar/FedFunds) rates.
In other words, small investors can vicariously borrow at institutional rates through the futures markets.. and get paid a fixed rate on the excess capital to boot.
Assuming one had already made the decision to invest in any certain index, and that the implied interest rates actully reflect those lower numbers at the time of investment, Peterffy’s strategy is rock solid.
