Questrade, TFTA, a change of rules, mine

This whole last few months I've been going on about the Tax Free Savings (Trading) Account (TFTA) and how I was going to use it for all of my trading. Yesterday I filled out the application and forwarded it to Questrade. They have a method of e-signing the forms, which may be only available to existing customers, that sped up the whole process. All I have to do is fax them a copy of my driver's license, EFT some cash and I should be ready to go in short order. Pretty simple and quick.

So, in reading the details I ran across the phrase "capital gains" when referring to what can grow tax free within the account. It occurred to me that the profit from short selling stocks is not, technically, capital gains and if push comes to shove with the government they are treated as regular income for tax purposes...again, not capital gains.

I used the online help feature and had my answer in a minute. No, shorting is not allowed in a TFTA. I actually should have known this as I knew that shorting was not allowed in an RRSP account either. I was blinded by the fact that I could short in a margin account and the gains looked really promising...my research was lacking.

I quickly went back over all of my previous trades to see how much of my profit would have been from short selling. This was easy enough as I have always kept a long/short profit ratio for all my tracking spreadsheets. Note that this is not a ratio of number of trades, just profit.

Overall I am running about 1:1. So half of my trading profit would not be counted. Seeing as my performance is close to 2% per day I would be just shy of my daily goal if I dropped half of my trades...or my trading profit. I consider that I usually stop at a daily maximum of 6 trades, more often 4. So if I was concentrating on making that many trades and with long only positions I may have been able to make 75% of the trades. So I might have seen 1.5% per day.

My options to adjust my trading plan include:

1) long only trades with the same plan that I have been using, result may be 25% - 50% reduction in profits

2) long in the TFTA, short in margin, result is taxable (max marginal rate) for all short profits so the overall effect would be pretty close to option 1), within 10%

3) variation of option 2) in that all profits at year end for shorts are contributed to my RRSP account whereby the taxation is negated but the downside is that these will be taxed upon withdrawal... perhaps at a lower tax rate at the time

4) variation of option 1) by using only the TFTA, trading my favourite stocks long and shorting the index that they are tracking through the use of a bear Exchange Traded Fund (ETF), result is the same tax free profit potential as I was planning on originally

Well, option 4 becomes the no brainer solution to my dilemma it would appear. In investigating the ETFs I start to wonder if I can trade them exclusively.

This would be easy enough as I just run the bear and corresponding bull ETF side by side with the related index they track and the TSX for the overall market and trade them back and forth. When one is rallying the other will be pulling back which means that one or the other will always be gaining...except in a true sidways market move. The difference in prices will necessitate using different position sizing for each which will look after the scaling according to the size of the move. Roughly a 1% gain in one will yield a 1% drop in the other.

In the interest of keeping it simple I think I will start out with option 1) only and see how it goes. I believe that the stocks I have selected will be seeing some gains over the next while so long positions will be many, I may have to increase my time trading by a bit though. If that does not pan out then I will play with the ETF and see how they work out for trade executions and perhaps mix it up from there.

I will have to wait for my TFTA to get going first as I really want to stay away from any gains in this 2009 tax year.

I should have known it was not going to be such an easy ride and that the testing was not yet complete. Too bad as I would have liked to have had this ironed out earlier. If I do some testing with the expectation of a loss then it will reduce the capital in my account as I cannot just "top it off" after testing is complete. $5K contributed is the limit no matter the trading losses incurred...unless I over-contribute and pay the monthly penalty. Questrade may enforce the maximum as their policy is worded in such a way at that is possible.

Jeff.