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19May/130

Why I use Interactive Brokers

While writing my dividend aristocrats articles I mentioned my use of Interactive Brokers, so I thought it would be a good idea to do an article about why changing to Interactive Brokers was the best trading decision I've made in my investing career.

There are pros and cons to every broker, and I've tried quite a few. The biggest con for me are the commissions and other fees. Paying $7.95 per trade plus options fees is ridiculous, it makes it really hard to make money writing options! If your game plan is just to buy and hold stock, then get any brokerage account you want, pay the high commissions and move on. The commissions aren't going to matter if you're looking for long term capital appreciation and dividend compounding. However, if you want to move in and out of positions or go short options for quick gains, you need low commissions.

The round trip cost factor

"Round trip" is a term to describe opening and closing a position, basically I want to know how much it's going to cost to open and close a position in order to calculate my break even point. If commissions are $1 per trade then I know a position will need to move more than $2 in order to have a profitable trade, this is elementary. However it gets tricky when you don't have massive amounts of money to offset the commission impact on a trade. I'll explain it with a quick example and visual aid:

Buy 100 shares at $5.00 per share

 

Interactive Brokers

Any other broker

Commission

$1.00

$7.95

Total investment

$501

$507.95

Break even point

$502

$515.90

BEP per share

$5.02

$5.159

Profit on sale at $5.10

$8.00

($5.90)

It might seem all a bit silly, because the idea is to make more than $8, but if you were to box trade that and make $8 every 5-10 minutes scalping, you'd finish the day with a decent amount of cash. Of course if we bought more than 100 shares the $7.95 would be further amortized, but the point is we're dealing with small positions here. Think about people just starting out and wanting to put on 50 share positions or less, the commissions are a massive setback.

Now take that example above and imagine it's an option trade with a $1.50 per contract fee. This is where I really got sold on opening an account with Interactive Brokers. IB only charges a per contract fee, and it can vary depending where the order is routed, but usually averages about $1 per contract, sometimes less. I've been usually getting $1.07 per contract on orders routed to CBOE, and sometimes $0.72 through NASDAQOM. This is huge...let's do that example one more time except use an option:

Sell 1 covered call: Ford $15 May 24 @ $0.22

 

Interactive Brokers

Any other broker

Commission

$1.07

$7.95 + $1.50

Total premium

$22-1.07 = $20.93

$22 – 9.45 = $12.55

Break even point

$19.86

$3.10

BEP per share

$0.1986

$0.031

Here I'm selling a covered call, just to generate some cash. The delta on this option is .601, so even a modest amount of movement could push this into the profit zone for me: a $0.20 drop in the stock would cause a $0.12 drop in the option premium, allowing me to buy back at $0.10 and pocket $9.86 in profit. Even time decay has a significant effect on a position with such a low break even point. Look at the other broker column, in this example you're basically writing options in the hope they expire worthless, because you can't close them early for a profit because the BEP is so ridiculous.

Maybe that's what most people do: write options with the intent of letting them expire. I'm different though, I like to book a profit. I like to swing trade the options sometimes. If the underlying is particularly volatile during the day, I'll close and re-open the same position multiple times, as long as it's trading within a box wide enough to profit from. It might be costing me the commissions, but in the long run it's improving my returns. If you sell a call at $2.00, buy it back for $1.80, and sell it again for $2.00, you didn't really lose any ground. If, then, at the end of the day you have closed the position, your cash balance is higher and you can do it all again depending on tomorrows action.

Don't get me wrong, I'm not trying to push these accounts to infrequent or newbie traders, I'm just making a point about how expensive most brokerage accounts are. In fact, newbies and infrequent traders should stay away, there are activity minimums and market data subscription fees that need to be offset your trading activity and income strategy. My currently monthly cost is $11.50 for market data, then the $10 minimum activity fee, which I always meet, except one time when they just deducted the difference of $1 from there. If you make enough dividends and do enough premium harvesting the minimums and fees can be covered easily.

The other great thing is the Trader Workstation platform. It has pretty much everything an average trader needs in one place, and once you learn how to use it you can unleash some pretty awesome power. They also have an iPad app which I use quite a bit when I'm not on my main trading machine, it works well but it seems a bit clunky. I've done a lot of trades on the iPad app and never had an issue with execution or market data due to the app itself, so I give it a thumbs up. But the real meat and potatoes is in the Trader Workstation (TWS) app for your PC or Mac.

The reason the platform sets IB apart is because most brokers use a simple web interface, lacking streaming market data. They also have clunky order entry processes that require multiple mouse clicks and confirmation pages. The IB TWS system makes it easy to set up a trade, check the margin impact, then execute on it. It allows order entry in a variety of ways: by clicking buy/sell on a chart ("chart trader"), by using the book to look at order action and decide your move ("book trader") or by simply using the main dashboard to create simple buy and sell orders.

All in all, it's a very robust package. This broker has truly captured my heart and I'm glad I made this decision. It's allowed me to put my investing into high gear, letting me put on positions that I couldn't afford previously, and helping me to learn about market participation. Check it out for yourself, I think you might find it's right for you too: InteractiveBrokers.com

I used to use a Sharebuilder account for my dividend compounding portfolio, and a bit of trading, but found that the IB account was much better. I still have my sharebuilder account, mainly because it's expensive and cumbersome to transfer the assets out of the account. Sharebuilder doesn't do a typical ACATS transfer like other brokers. They require a medallion signature guarantee and some fees to get your shares. I do plan to move these eventually, but for the time being I'm leaving it because my sharebuilder account is connected to my savings account, so I can easily dump off the dividends into a higher interest account. I'm not reinvesting dividends right now.

On that point, one last bit of food for thought. Since the IB commission is $0.005/share with a minimum $1/share, I'm basically doing my own Sharebuilder. See, I used to pay $12/month for 12 automatic Tuesday trades. Without the subscriptions it's $4 for an automatic trade. I'm basically paying the same as an automatic trade, but having to buy full shares and also not restricted to Tuesdays. Think about it.

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