Permanent Portfolio via Options

[Clive]

Being that options are a net-borrowing and lending market, if you buy the Call, you put out money for that call. If you sell the Put, you receive a credit.

You might buy 1 at-the-money (ATM) Call, sell 1 ATM Put, for almost zero premium. It is a way to replace buying a stock by buying a Call and selling a Put for almost zero cost.

For posterity for 4x25 Permanent Portfolio's to perhaps reference in a years time :

[Calm Man]

If it goes down a lot, then you are the owner of a call worth nothing and can get put the stock at any price down to zero. It seems like the risk is higher to me.

[Ketawa]

You're creating a long position without investing any actual money, so this is using extreme leverage. Far less efficient than simply buying the ETFs, unless you're actually trying to use leverage. You will lose to bid/ask spreads and commissions.

[Clive]

Buying call is long, selling put is long, 50% of each ATM = 50% delta on both parts = 100% delta, and will replicate the underlying penny for penny. As Ketawa said - long position without investing money. But is only leveraged if you decide to buy more delta than you would have held in the underlying.

Yes - the cost is bid/ask + commissions.

For each asset, If the underlying declines a lot, you end up with the same as if you'd held the underlying - but in concept other holdings would have risen - no different overall to the conventional.

[wshang]

The real danger in a synthetic stock position is assignment. If your short put is assigned prior to expiration, as the opposite party exercises the option early. If would force you to purchase the actual stock. The other problem arises when the underlying has moved away from your initial position and the gammas are no longer offsetting. This could be especially bad near options expiration when closer option side's extrinsic value is largely gamma and your theta is essentially zero. Options trading is great on paper, but you always have to be ready for the assignment.

[market timer]

Before creating a synthetic position using options, I think it would make more sense to reduce the 25% allocation to cash.

[Ranger]

Yes - the cost is bid/ask + commissions.

For each asset, If the underlying declines a lot, you end up with the same as if you'd held the underlying - but in concept other holdings would have risen - no different overall to the conventional.

You pay commissions and Bid/ask spread, even if you implement thru' ETF's. So no difference there.

You are exactly right. If you implement the strategy in non-margined account (put up the cash or Tbills as collateral for those naked options) then performance will be similar to the conventional. In margined account performance will be different because the capital required will be less.

I believe since you are using broad based index options, you need to put up 15% of the index value for each side. So the leverage will be 1:3.33 for SPY and TLT. GLD is not considered as an index option, so leverage will be 20% per side, so the leverage will be 1:2.5. If you deposit Cash for cash portion of PP, entire portfolio leverage will be slightly above 2. In fact, if you set up PP through ETF, in margin account it will have same leverage.

http://www.cboe.com/tradtool/marginmanual2000.pdf

But main reason investors use PP is because of reduction in portfolio volatility it offers. By employing leverage, you are defeating its main purpose.

[Clive]

Assignment is more likely to occur due to dividends. Gold pays no dividend and stocks might be held via European style that can only be exercised at the expiry date. Leaving the TLT short put as the primary assignment risk holding. Over mid to longer term periods, the Permanent Portfolio treasury barbell (short term/long term 50-50) is little different to allocating those funds to a intermediate term Permanent Portfolio comparison

In practice the portfolio might be comprised of a synthetic long stock (options), physical gold and cash (shorter term deposits). Under a more punitive regime - perhaps with high inflation, high yields/interest rates, high taxation (1970's/80's) that would have a much smaller footprint. 7.5% of total funds deposited as Options collateral, the rest elsewhere (67.5% cash and 25% gold). When levelled to the same exposure as you would have held in a conventional Permanent Portfolio there is no leverage involved. If for whatever reason you decided to scale up exposure above that (leverage) then naturally you'd be holding an entirely different portfolio.

Gold Options might initially be used in order to take physical delivery, perhaps at lower cost than it would to purchase gold elsewhere.

But main reason investors use PP is because of reduction in portfolio volatility it offers

I'd add "freedom" to that. Having all of ones assets exposed to a single geopolitical risk - where a single entity might inflate ('legally' counterfeit (print) and spend at the expense of all other notes), tax or confiscate is a greater risk perhaps than that of options counter-party risks and/or the risk of losses from having cash deposits more diversely distributed across multiple geopolitical regions (higher probability of small losses is generally better than a lower probability of a large loss).

[Clive]

The other problem arises when the underlying has moved away from your initial position and the gammas are no longer offsetting. This could be especially bad near options expiration when closer option side's extrinsic value is largely gamma and your theta is essentially zero.

Gamma isn't a concern providing both sides remain intact. If the sell put is exercised then just roll (close the call (call exercise option is in your control) and restart). When both sides were acquired at the same strike price and for a near zero combined cost, one side or the other will be valued at the difference between the strike and current price or more (depending upon the amount of time value remaining to expiry). The only amount at risk is if the spread between the buy call and sell put is net negative (against you) at the time of opening the positions - in the first posting snapshot it indicates no risk (surplus) had either all three been traded, or just stocks been traded i.e amount paid out for calls was less that the money received for selling the puts.

When only a European style synthetic long stock is held, then at expiry one side will be valueless and the other side will be valued at the difference between the strike and current price. 1 contract of 100 shares profit (loss) being no different to the profit/loss had 100 shares of the underlying been held. (For smaller portfolios using the mini can reduce the granularity down to 10 shares.)

[wshang]

I've been trading options for 20 years +, if this strategy is something you have done successfully, my hat's off to you. What's not clear to me is whether you have done this successfully or just thinking through the process. Seems needless when the PP is so easy and low maintenance.

[Clive]

I wouldn't buy and hold a PP - too much risk. Below average rewards (opportunity cost) and fails just when you need it to protect the most. In effect paying an insurance premium only to see the insurance fail when you need to claim. 1933, gold confiscated to immediately ramp up the price of gold (direct confiscation). 1970's/80's, high inflation, high yields, high taxes - (indirect confiscation). So no its not something I am doing myself - but its interesting to consider alternatives.

In a high yield, high inflation, high taxes (and no tax efficient space - as was generally the case back in the 70's/80's), paying a dividend and receiving a dividend (similar sized short and long holdings) is tax neutral, which is better than inflation 15%, yields 15%, less taxes (in the UK taxes on income rose to around 40% for basic rate (most common) taxpayer band during those years, such that 15% gross yield = 9% net yield (-6% real)).

Gold in gross real annualised gain terms from 1980 to end of 2011 was negative (-0.3% annualised). Gross nominal was around +3.1% annualised, growing $10,000 to $26,600 over those years, such that a $16,600 taxable 'profit' on nominal may have fallen due, compared to something that didn't even keep up with inflation. Worse still is if you compare over 1980 to 2000 i.e. before the up-run in gold (-7% annualised real)!

Boglehead philosophy of diverse, tax efficient is more time proven. Whilst maybe more volatile during the interim period, what matters more is the final outcome when you actually get to spend what you had been saving/investing for. Gaining more to later give back some but still be ahead is better than gaining less and then being clobbered when you need to claim but your insurance is declared null and void.

[hazlitt777]

Clive,

I would stay far away from such complexity and embrace the simplicity of the permanent portfolio or some version of it. As a prior poster mentioned, there are lots of costs involved in using options not to mention hidden risks.

my two cents...

[Clive]

Thanks - but - gyroscopes spin for a while, looking pretty stable, but then tumble - the Permanent Portfolio is not something I'd invest in other than as a short term play. AFAIC valuations matter and the PP has had its day - at least for a while. But its a nice combination of assets to use as an example for alternative methods of holding exposure to assets in a manner that might be less exposed to confiscations.

To be absolutely clear, this thread is hypothetical example(s). I'm not investing in those options, nor the Permanent Portfolio assets.

[rmelvey]

Clive,

What are you currently doing with your money?

[Clive]

What are you currently doing with your money?

Spending it Thrifty 'til fifty then spend to the end. But not in the 'to consume wastefully' definition manner.

[rmelvey]

What are you currently doing with your money?

Spending it Thrifty 'til fifty then spend to the end. But not in the 'to consume wastefully' definition manner.

With interest rates where they are, that actually makes some sense.

[grabiner]

Being that options are a net-borrowing and lending market, if you buy the Call, you put out money for that call. If you sell the Put, you receive a credit.

You might buy 1 at-the-money (ATM) Call, sell 1 ATM Put, for almost zero premium. It is a way to replace buying a stock by buying a Call and selling a Put for almost zero cost.

However, your broker will require collateral for that put, because of the risk that the put will be exercised and you will have to come up with the difference between the strike price and the market value. And if the market price falls, your broker may require you to increase your collateral or buy back the put. Therefore, what you will actually have is a call, a short put, and a cash position which is large enough to satisfy your broker. This is a leveraged position, with the broker limiting the leverage.

You can do the same thing without options, by buying on margin; again, you get exposure to the stock without putting all the money up. And again, there is the same type of risk; if the market price falls, you will get a margin call and have to put up additional cash or sell some of your stock.