Investing in T-bills (Part 2)

Last time I presented Investopedia information on the basics of T-bills: what they are, how they work, etc. Today I’m going to start discussing why to consider investing in them.

I invest in T-bills to get a better interest rate on cash than I otherwise would. I tend to have free cash in my brokerage account. The brokerage currently pays 0.35% interest on that cash. According to the Bankrate website, the national average yield for savings accounts is 0.57%. T-bills are currently paying over 5.0% interest.

Borrowing brokerage money to invest in T-bills would be a losing proposition. Suppose I open a margin account with $100,000 cash. I can buy stock with $100,000 and T-bills with $50,000. I will make 5% interest on the T-bills, but since that $50,000 is borrowed from the brokerage I will have to pay upwards of 13% interest. This is a guaranteed loss of at least (13% – 5%) = 8%. Bad idea… really bad idea.

For those investing in stocks, T-bills may not add much benefit. A stock investor opens a brokerage account to buy stocks. Most of the cash will therefore be deployed to that end. $95,000 may be used to purchase stock in a $100,000 account. This leaves only $5,000 to buy T-bills. It may still be worthwhile to do so, but T-bill investing does carry a minimal time commitment (to be discussed later).

Because options are leveraged instruments, cash outlays are different. Options allow me to control stock for a fraction of the cost. This means more leftover cash that I can conceivably use to purchase T-bills.

Imagine buying calls in the hypothetical account discussed above. With SPY at $509.83/share, I can buy 200 shares of SPY for $101,966. Alternatively, two 510 calls would cost me $2,746. This allows me to effectively rent 200 shares of SPY for 62 days. My position is then worth the difference of SPY and $510 [multiplied by two (options)]. If SPY is less than $510 then my position expires (i.e. “goes out,” “ends up”) worthless. If SPY is at $524, then my position is ~$2,800 (slight gain). If SPY is at $530, then my position is ~$4,000 [a much larger (percentage) gain].

With calls, I take on the risk of losing the full $2,746, but this is only 2.7% of the cost to buy shares. The leftover cash can be used to purchase T-bills. Interest received would be 0.05 * (100,000 – 2,746) * (62 / 365) ~ $849. With shares, because I borrowed $1,966 to establish the full position, I would actually owe 0.13 * 1,966 * (62 / 365 ) ~ $43 . The difference is $892 in about two months.

Interest aside, at the end of those two months the SPY position could also be down $2,746 were SPY to fall $13.73 (to $496.10/share). While this is an equivalent loss to the option position, I retain ownership of the shares and can subsequently recoup the loss if SPY moves higher. Expiring worthless means the option position can never rebound.

I will continue next time.