Margin Fees on IBKR

This image demonstrates fees on brokerage accounts.
Advice & Tips / How to Use / Learn with AP

Margin Fees on IBKR

The average annual return of the S&P 100 Hedged Strategy is 14 % before deducting any fees, commissions, and expenses. To implement this strategy, we use the Interactive Brokers margin account. When calculating the net return, we have to, among other things, discount the interest paid on margin fees (loans). The main topics of the article are why we are borrowing funds to implement this strategy and how we can calculate the amount of money we are going to borrow.

In search of the most robust strategy, our analysts have discovered that we can achieve the best results using margin accounts that are linked with margin fees. These accounts allow us to borrow funds for trading from our broker. This way, we can increase our buying power and maximize the return while minimizing the risk we assume. However, we will be paying interest on the loan for its duration.

Let us first explain how our strategy works. The S&P 100 Hedged Strategy uses a leverage of 1.5. Therefore, to calculate the capital used for trading, we need to add 50% to our initial investment. For example, when investing CZK 200,000 into the strategy, we open trades worth CZK 300,000. It would seem that the amount of money we borrow equals CZK 100,000, but that is not correct.

To figure out the actual amount we are borrowing, we need to understand how is our portfolio created and how it is purchased.

The S&P 100 Hedged Strategy builds our investment portfolio by buying the 20 most undervalued stocks and selling the 20 most overvalued stocks. In total, the portfolio is composed of 40 different companies. Purchased stocks account for 60% of the total value of our initial investment after applying leverage, while sold shares account for the remaining 40%. All these stocks belong to companies based in the United States traded in American dollars.

It is something to be aware of, as the amount of money we borrow from a broker will depend on whether we keep US dollars or another currency in the account. We will not be borrowing any funds if we deposit US dollars into our account straight away. We also have the option to exchange our currency for US dollars on the platform itself. If we want to trade US stocks but do not have any USD on our balance, we will have to borrow some and be subject to the interest payments. It is due to the purchasing process itself. We will explain this with an example when holding Czech crowns in the account.

If we want to invest CZK 215,000 (as of today, the equivalent of USD 10,000), our rebalancing application calculates that we will be buying USD 9,000 worth of stocks and selling the equivalent of USD 6,000. Our CZK funds remain untouched during the whole process. For purchasing stocks, we are borrowing USD 9,000, but when selling, we are not borrowing any funds. Instead, we are borrowing the stocks and then immediately selling them. This process of short-selling stocks adds USD 6,000 to our balance. Afterward, the balance on our account will be CZK 215,000 and – USD 3,000. The negative USD balance signals that we have borrowed these funds and will be paying interest fees (margin fees) until we repay the loan.

Therefore, if we hold any other currency than the US dollar in our account, we will borrow USD equivalent to 30% of our initial investment. At the time of writing, the annual interest rate for US dollars is 1.58% when borrowing less than USD 100,000. The interest rate may fluctuate, so we always recommend checking the current rate on the corresponding page. There, you can also find a calculator for the so-called “blended rate” for amounts exceeding USD 100,000. Users from the US can choose between the “Pro” and “Lite” accounts, while EU users are getting the equivalent rates of the “Pro” account. (PrtScr from the Interactive Brokers).

It is important to remember that we can avoid paying interest payments if we keep a USD balance for trading. However, we will expose ourselves to the currency risk by doing so. During the trading period, the CZK might appreciate against the USD, and we will realize an exchange loss when exchanging USD back to CZK, even though the trading itself was profitable. The currency risk is always present when trading US stocks because we generate all profits and losses in USD. We materialize the currency risk when exchanging these profits into our preferred currency. Keeping our balance in CZK reduces the extent of the currency risk, but at the same time, it makes us borrow USD.

We shall decide what currency we will maintain on our account before implementing the strategy. Those who expect the CZK to appreciate against the USD will choose CZK and vice versa. When choosing the currency, we should also consider the interest payments we will be subject to if we maintain our account in a different currency than US dollars. In the presented example, with an account maintaining a CZK balance, the interest paid was around 0.5% of our initial investment. That is USD 50 paid annually. It is up to everyone to assess the potential benefits and risks that each option has.

The calculations of the interest payments/margin fees on the margin account mentioned in the article are valid for a specific strategy S&P 100 Hedged Strategy and broker Interactive Brokers.