Is The Russell Bubble About To Pop – Interactive Brokers Hikes Small Cap Margins To 100%

Three months ago, in anticipation of the now traditional year end ramp in “story stocks” (i.e., those companies in the Russell 2000 that have negligible or negative cash flow, yet have a “story” to them, and/or massive short interest usually for a reason) we penned an article titled “Presenting the most shorted stocks” focusing on the 50 most shorted/hated names in the Russell 2000. We suggested that for “the overly aggressive out there, and those who are tired of watching paint dry, one option is to create an equal-weighted basket of the 20 most hated names, and hope for the arrival of the one catalyst that forces a massive squeeze.” That, or just await the traditional rotation into high beta garbage that comes every year like clockwork in the last months of the year.

Sure enough precisely this happened in 2012 as it always does, with the Russell 2000 outperforming the S&P notably since November, with the index hitting all time highs a few days ago, yet our most-shorted basket crushing the returns of both the S&P and the broader Russell 2000 by a substantial amount (see chart below).

Alas, those hoping that that the Russell bubble will continue indefinitely may want to promptly reassess, as moments ago Interactive Brokers just announced it would hike both initial and maintenance margins on all low cap stocks (under $250 million in market cap) beginning January 11, 2013, to 100%!

From IB:

Margin Increase on Low Cap Securities

Please be advised that IB has increased the initial margin rates to 100% on low capitalization stocks (currently defined as companies with less than $250 million in market capitalization). The maintenance margin increases will occur in stages starting with an increase to 50% beginning after each region’s market close on Friday, January 11, 2013 and will be implemented as

Friday January 11, 2013: Maintenance Margin – 50% Wednesday January 16,2013:
Maintenance Margin – 75% Monday January 21, 2013: Maintenance Margin – 100%

The list of stocks which are subject to this margin increase can be found on the following page: ( IB../2007 )

Upon implementation, any of the incremental margin increases may result in a margin deficit in the account. A margin deficit implies that an account becomes subject to automated liquidation. Please carefully review the current positions within your account and adjust the portfolio accordingly.

This means that countless trading accounts will be forced to dump a lot of stocks immediately or wait for the dreaded “automated liquidation” where IB decides whose accounts to liquidate. And since one broker is never alone, expect all others to promptly follow suit with a comparable margin increase that is sure to have a major impact on the index price of the Russell, of whose 2000 stocks, some 508 have market caps under $250 million.

And should the margin hike move even more aggressively and impact say companies with a market cap under $500MM, that would impact a whopping 951 of the companies in the Russell.

Needless to say, we would urge anyone still nursing profits in to the “most shorted Russell 2000″ basket to close out post haste.

A list of the companies directly impacted by the IB move are listed on this following page.

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