Bogleheads

[ikkyu]

Finally, this article represents a serious look at the famous 90:10 portfolio written about by Zvi Bodie and Nassim Taleb. This is written by Dr. Considine, who uses monte carlo simulations to consider the strategy and approximate the fair value of the options.

http://www.advisorperspectives....anning.php

Here is the whole thing in PDF:
http://www.advisorperspectives....anning.pdf

Highlights include:

"The obvious appeal of Bodie’s 90/10 strategy is that there is an absolute floor on portfolio losses that a decline in equities can cause, even in the worst market conditions. (This does not, however, mean that the portfolio cannot lose more than 10% of its value.)"

"Buying calls on a higher beta / lower yield index ETF adds some additional benefits to the 90/10 strategy. There is an additional change in the outcome of a 90/10 type of strategy in buying calls on options with beta greater than 100% relative to the S&P 500: One can further increase the effective leverage with respect to the S&P 500. Higher beta assets tend to further amplify moves in the S&P 500."

And:
"Conclusions

Bodie’s 90/10 strategy can be sanity-checked using Monte Carlo simulations and by benchmarking using the current prices of index options vs. the Monte Carlo model. Using this framework, it is straightforward to look at how variations of the strategy impact outcomes.

There has never been any doubt that the basic mechanism that Bodie proposed could work. The question has been whether such a strategy would work in practice, given the prices at which options are trading at any specific time. As the prices of options vary, the effective leverage changes. Given current options prices, the 90/10 strategy makes sense today.

A range of practical variations on the 90/10 type of strategy can make sense for retirement planning. Their main attraction for investors is the absolute floor that they provide on the equity portion of the portfolio.

One of the largest challenges to this type of strategy is its conceptual complexity. On the other hand, as Bodie has noted, equity-linked notes that provide this type of structure to retail investors have been adopted fairly widely in Europe. Advisors who take the time to create their own 90/10 and related strategies can provide a floor on equity market loss potential, while maintaining transparency and keeping costs down."

He also links this good article on Bodie and his thoughts this approach, which is apparently sold as a mainstream product in Europe!
http://www.advisorperspectives....oducts.pdf

Cheers from Osaka,
john

[ikkyu]

A good variation on this would be to use a treasury STRIP bond of the same duration as the option to have a know minimum payout. This would be a true Equity Linked Note that could be structured to maintain principle protection.

Cheers,
john

[mpt follower]

see
http://www.bogleheads.org/foru....1257146592
_________________
Erwin

[Verde]

[Rodc]

This article, IMHO, is just not all that. Read with a critical eye towards the limitations of Monte Carlo simulations, thinking that 10 years is "the long run", and author biases (consider how is toast is buttered).

Not that the message is all bad, just not really all that well backed up.

IMHO, this is light weight stuff, the sort of analysis we might see someone here bang out: worth something, but not fully fleshed out.
_________________
"all standard caveats apply"

[ddb]

[ikkyu]

Greeting folks. Now that I have looked at it more closely, there may be several errors in this article.

Verde, $1390(100x $13.90/109 would yield .078 contracts per share. Also, he seems to assume a delta of one, when initial delta would be around .5 for ATM.

I will have to look at this in the daylight.

My apologies if I may have inadvertently advertised something that was incorrect!

Cheers from Osaka,
john

[Wagnerjb]

[Verde]

This article by the same author makes it clear that he – like Warren Buffett believes that option pricing is flawed and presents a free lunch.
http://seekingalpha.com/articl....ummer-2009

[Indexer88]

The LEAP portion should be replaced by total stock market allocation in my view.

[xerty24]

[Wagnerjb]

[Roy]

[Wagnerjb]

[dandan14]

[Lbill]

I'm not sure that Bodie is advocating a long-term "asset allocation" approach using equity LEAPS and TIPS. He's merely suggesting that you first invest as much as you need into one "bucket" of TIPS to assure that your present, or future, income needs are met. Any funds that you choose to designate as "surplus" can be invested in (preferably) a second "bucket" of actual or synthetic Equity Participation Notes (EPNs) instead of a stock index. You can construct a synthetic EPN yourself by investing enough in two-year STRIPS to assure principal preservation at maturity, and the remainder in 2-year equity LEAPS. This way, you have some exposure to significant stock market gains (which you would harvest when and if they occur), while at the same time preserving your original capital. You can keep "rolling over" this EPN strategy every two years. Of course, right now is not a great time to use EPNs because the low interest rates force you to invest a very high percentage of your "surplus" capital into 2-year STRIPS. It would be interesting to compare this approach to simply investing in a stock index as dandan14 did for the 90% TIPS/10% LEAPS strategy.
_________________
"Whenever you find yourself on the side of the majority, it is time to pause and reflect." ~ Mark Twain
"A foole and his money is soone parted." - J. Bridges, 1587

[ddb]

[Lbill]

For those interested in implementing Bodie's synthetic EPNs, here is an online tool he provides:

http://www.wealth2k.com/downloads/zb/epn.html
_________________
"Whenever you find yourself on the side of the majority, it is time to pause and reflect." ~ Mark Twain
"A foole and his money is soone parted." - J. Bridges, 1587

[stratton]

[Lbill]

Paul - I hope you post your findings.
_________________
"Whenever you find yourself on the side of the majority, it is time to pause and reflect." ~ Mark Twain
"A foole and his money is soone parted." - J. Bridges, 1587

[Quantext]

Hi guys:

I am very pleased that you guys have taken up this discussion because I increasingly think that Bodie is on to something important--not that its the only way to invest but rather that it is important to consider this. For what its worth--and this is not advice for anyone else--I am increasingly implementing variations on this strategy and other long-term options strategies in my own investing and you clearly lean a lot by doing so.

There are some subtle issues in Bodie's original analysis of stock risk and his later paper on the 90/10 strategy that you cannot understand without really thinking about it. I dismissed this approach just as most of you are for years when I ran across it.

While many of you are concerned about Monte Carlo and what it means, I will first note that the conclusions of the MC are more illustration than anything else--its a way to look at second-order effects. Bodie's basic logic is simply confirmed by the MC but neither his original logic nor the MC is in any way proof of anything. For those who actually want to learn more about MC, I have written something like 130 articles on this topic over the years and many of them pertain to various forms of validation and testing.

There are a few obvious things that I would like to respond to from the posts here. First, the basic arithmetic: it is correct. I have checked it and I also use options regularly. The $13.9 cited earlier in your posts here was for the 2.2year option and the 9.3 year leverage ratio was for 2 year options. I believe that this is clear in the original article.

The biggest hurdle that I had to get over with this strategy is the rolling of options--and that has been mentioned here. I am working on examples to further eludicate this issue.

You guys are the most financially literate group of individual investors out there. My overall suggestion would simply be to educate yourselves about options and what they can provide. Even if you never use options yourself, they can provide valuable insight into what is going on in the markets. As I have noted in the years prior to the crash, one of the most worrisome signs out there was that long-dated options had implied volatility far higher than trailing historical volatility: the market was signaling for a volatility shock well before it happened. Sadly, the vast majority of investors and advisors do not pay attention to the options market as a source of information.

Cheers,

Geoff

[Lbill]

Geoff- Thanks for your post. I believe you are correct that it would be a good idea to educate ourselves more about the use of options as part of an overall portfolio strategy. What do you think about Bodie's idea of using synthetic Equity Participation Notes as a way of gaining market exposure? This is different from a 90% TIPS, 10% LEAPS approach. As I understand it, you would, for example, allocate the 10% to synthetic EPNs and not to LEAPS, per se. Provides an extra layer of security because that 10% portion would never decline lower than it's original principal value; whereas, you can lose your entire 10% invested in LEAPS if they expire worthless.
_________________
"Whenever you find yourself on the side of the majority, it is time to pause and reflect." ~ Mark Twain
"A foole and his money is soone parted." - J. Bridges, 1587

[leftcoaster]

[fluffyistaken]

[DriftingDudeSC]

Huh oh....what happen to KISS?

[Lbill]

DD - don't forget the last "S" stands for stupid.
_________________
"Whenever you find yourself on the side of the majority, it is time to pause and reflect." ~ Mark Twain
"A foole and his money is soone parted." - J. Bridges, 1587