Lifecycle Investing - Leveraging when young

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Lee_WSP
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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Mon Aug 12, 2019 7:35 pm

rascott wrote:
Mon Aug 12, 2019 7:25 pm

$190 call option for Sept 2020 is about $97, as of today.
How many of these are issued? It's showing a volume of 1 at Yahoo Finance.

And are these European options? The price indicates you cannot exercise them early otherwise you could just instantly exercise it, no?
Last edited by Lee_WSP on Mon Aug 12, 2019 9:22 pm, edited 1 time in total.

rascott
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Re: Lifecycle Investing - Leveraging when young

Post by rascott » Mon Aug 12, 2019 7:45 pm

Lee_WSP wrote:
Mon Aug 12, 2019 7:35 pm
rascott wrote:
Mon Aug 12, 2019 7:25 pm

$190 call option for Sept 2020 is about $97, as of today.
How many of these are issued? It's showing a volume of 1 at Yahoo Finance.
I would use a strike price that had a lot more open interest.... looks like the 180 strike would be more liquid. Further down in strike price you go, the lower your leverage position.
Last edited by rascott on Mon Aug 12, 2019 7:46 pm, edited 1 time in total.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Aug 12, 2019 7:45 pm

Lee_WSP wrote:
Mon Aug 12, 2019 7:05 pm

If you can show me statistics on this, I will reconsider my ardent opposition to options as leverage. But so far, I have not found any information to refute the idea that options are generally bad other than a few anecdotal posts by traders who claim to have succeeded.
Let's put it another way. I claim that a 3:1 leveraged LEAP expires worthless (the thing you complain about the most) in situations where 3:1 futures leverage of other types would have wiped you out. In both cases, if the market dips by 33%, you lose everything you bet.

But unlike other forms of leverage (like someone with a mortgage and stocks), the call losses are capped. Here's an example. Both people have 10k to start with:

Person A buys 10k of LEAPs calls with 3:1 leverage.
Person B takes out a HELOC of 20k and, with the 10k he has, invests 30k in the market. This is also 3:1 leverage.

The market dips 50%.
Person A's calls all expire worthless. Your worst nightmare! He has no money left.
Person B has 15k in equities left and a HELOC of 20k. This person has a negative net worth.

Person A is in a better position. "But person B still has his equities, which can go back up! Person A has nothing" you shout. Person A could now tap into their HELOC and invest 15k of HELOC money. Now both Person A and B have the same in stocks. But A literally owes less money (15k vs 20k).

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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Mon Aug 12, 2019 7:51 pm

Between those two options I agree, options are better. But I still say no debt is even better. A leveraged ETF can give you most of the leverage this strategy seeks and behaves more like owning the equity. The only additional risk is the ETF itself going under.

MoneyMarathon
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Re: Lifecycle Investing - Leveraging when young

Post by MoneyMarathon » Mon Aug 12, 2019 7:55 pm

305pelusa wrote:
Mon Aug 12, 2019 7:45 pm
Let's put it another way. I claim that a 3:1 leveraged LEAP expires worthless (the thing you complain about the most) in situations where 3:1 futures leverage of other types would have wiped you out. In both cases, if the market dips by 33%, you lose everything you bet.

But unlike other forms of leverage (like someone with a mortgage and stocks), the call losses are capped. Here's an example. Both people have 10k to start with:

Person A buys 10k of LEAPs calls with 3:1 leverage.
Person B takes out a HELOC of 20k and, with the 10k he has, invests 30k in the market. This is also 3:1 leverage.

The market dips 50%.
Person A's calls all expire worthless. Your worst nightmare! He has no money left.
Person B has 15k in equities left and a HELOC of 20k. This person has a negative net worth.

Person A is in a better position. "But person B still has his equities, which can go back up! Person A has nothing" you shout. Person A could now tap into their HELOC and invest 15k of HELOC money. Now both Person A and B have the same in stocks. But A literally owes less money (15k vs 20k).
It'd help if you added what A does if he gets his money back... after a few years, does he stop playing the options game with all his money? If so, when and how does that work out over time?

For example, if A and B were savers who started in the year 2000 or in 2005 or something like that, and the year 2008 was an 'expire worthless' year.

Seems like there might be a risk that A is just about to dial back his use of options... but then gets zero'd out. Do we assume that he gets back up and starts buying options again?

The biggest tail risk could be increased market volatility overall. For example, a wipeout event every 3 to 6 years. That'd really hurt.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Aug 12, 2019 8:04 pm

Lee_WSP wrote:
Mon Aug 12, 2019 7:51 pm
Between those two options I agree, options are better. But I still say no debt is even better. A leveraged ETF can give you most of the leverage this strategy seeks and behaves more like owning the equity. The only additional risk is the ETF itself going under.
Ok the problem I have with the LETFs is as follows:

So far with options, futures, mortgages, etc, we only need to know the start and end points to calculate profitability. The market could rise 20% then dropped 59% and the scenario would have been identical as if the market had simply dropped 50%.

But LETFs reset their leverage. So now the path the market takes matters. The LETFs will do worse on the first scenario (an increase, then a drop) than in the latter.
Personally, I feel pretty good about the market going up over the decades. But I have no idea how it will get there and the path it will take. So I prefer to use leverage that works independently of the path the market takes.

The ironic part is that I'm doing this whole Lifecycle Investing strategy to reduce sequence of return risk and diversify temporally. Meaning, I know the market will go up in the long term but if I just DCA my savings, the path it takes will matter (I will do worse if it rises first then drops than vice versa).
So why would I use a leverage option where sequence of returns matters again?

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Re: Lifecycle Investing - Leveraging when young

Post by FIProfessor » Mon Aug 12, 2019 8:08 pm

FIProfessor wrote:
Sat Jul 20, 2019 2:13 pm
In a taxable account, another possible advantage of LEAP calls over futures is that if you hold them over a year, they're taxed as long term capital gains, whereas futures are taxed at a 60/40 split between long and short term capital gains. (But conversely, compared to margin loans, they both have a disadvantage in that their implied borrowing costs are not deductible.)
The recent discussion about the tax implications of options has caused me to realize that my claim that borrowing costs are not deductible was not right.

If they're exercised, the option's premium is factored into the cost basis of the stock you acquired by exercising. So the direct part of the borrowing cost (as opposed to the implied costs from foregone dividends) is thereby effectively deducted from later capital gains when the stock is sold. For the implicit costs, you don't deduct them in this way, but then, you also don't have to worry about paying taxes on these dividends in the first place.

I haven't thought through what happens in the case where you sell the option early.

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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Mon Aug 12, 2019 8:09 pm

The volatility decay of a daily reset fund is actually not any worse than a monthly reset. You actually want it to reset daily because if it didn't, you're either getting more or less leverage than you think.

If the underlying asset goes up, your leverage decreases if the leverage is not reset. Vice versa.

Otherwise, fair enough, like I said, it's your money. It's very personal choices we each must make.

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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Mon Aug 12, 2019 8:11 pm

FIProfessor wrote:
Mon Aug 12, 2019 8:08 pm
.

I haven't thought through what happens in the case where you sell the option early.
The option itself becomes the asset. You take the cap gains or loss. Short or long.

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Re: Lifecycle Investing - Leveraging when young

Post by FIProfessor » Mon Aug 12, 2019 8:17 pm

Lee_WSP wrote:
Mon Aug 12, 2019 8:11 pm
FIProfessor wrote:
Mon Aug 12, 2019 8:08 pm
.

I haven't thought through what happens in the case where you sell the option early.
The option itself becomes the asset. You take the cap gains or loss. Short or long.
Certainly, but I meant whether my implied borrowing cost ends up being effectively factored into that, so that the implied borrowing costs gets "deducted" as it would with margin interest.

Thinking about it a bit more... suppose I buy a deep in the money call option that will expire 2 years from now. Let's pretend that the underlying stock does not issue dividends. Imagine that after 1 year the underlying hasn't changed in value. I decide to sell. My call option will have likely decreased in value, since someone buying that option today is effectively getting a loan for a much shorter period of time. So the loss I realize for tax purposes is indeed related to the borrowing costs.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Aug 12, 2019 8:37 pm

MoneyMarathon wrote:
Mon Aug 12, 2019 7:55 pm
It'd help if you added what A does if he gets his money back... after a few years, does he stop playing the options game with all his money? If so, when and how does that work out over time?
At some point, Lifecycle Investing will dictate that A does not need to leverage so much because he can hit his targets. So then A could buy options with less leverage, or use a portion of his money with no leverage (just stocks) and the rest with 3:1 leverage. As time goes by, the portion at 3:1 decreases until all A has are stocks and he can meet, without leverage, his target allocation.
MoneyMarathon wrote:
Mon Aug 12, 2019 7:55 pm
Seems like there might be a risk that A is just about to dial back his use of options... but then gets zero'd out. Do we assume that he gets back up and starts buying options again?
That's exactly what happens.

Personally, I would try to up the leverage at this point in order to try to maintain an equity target exposure. Getting liquidated (like person A would here, or person B who had 3:1 leverage in futures) forces a "sell low, buy high" that I dislike. I don't like my results to be path-dependent.

Clearly this requires very conservative leverage and a stream of savings capable of weathering debacles like 2008. This strategy is not for everyone.
Lee_WSP wrote:
Mon Aug 12, 2019 8:09 pm
The volatility decay of a daily reset fund is actually not any worse than a monthly reset. You actually want it to reset daily because if it didn't, you're either getting more or less leverage than you think.

If the underlying asset goes up, your leverage decreases if the leverage is not reset. Vice versa.
Huh deja vu. That was my entire argument with poster "no simple". If you go back a few pages, you'll see some of my responses.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Aug 12, 2019 8:43 pm

FIProfessor wrote:
Mon Aug 12, 2019 8:08 pm
FIProfessor wrote:
Sat Jul 20, 2019 2:13 pm
In a taxable account, another possible advantage of LEAP calls over futures is that if you hold them over a year, they're taxed as long term capital gains, whereas futures are taxed at a 60/40 split between long and short term capital gains. (But conversely, compared to margin loans, they both have a disadvantage in that their implied borrowing costs are not deductible.)
The recent discussion about the tax implications of options has caused me to realize that my claim that borrowing costs are not deductible was not right.

If they're exercised, the option's premium is factored into the cost basis of the stock you acquired by exercising. So the direct part of the borrowing cost (as opposed to the implied costs from foregone dividends) is thereby effectively deducted from later capital gains when the stock is sold. For the implicit costs, you don't deduct them in this way, but then, you also don't have to worry about paying taxes on these dividends in the first place.

I haven't thought through what happens in the case where you sell the option early.
FIProfessor wrote:
Mon Aug 12, 2019 8:17 pm
Lee_WSP wrote:
Mon Aug 12, 2019 8:11 pm
FIProfessor wrote:
Mon Aug 12, 2019 8:08 pm
.

I haven't thought through what happens in the case where you sell the option early.
The option itself becomes the asset. You take the cap gains or loss. Short or long.
Certainly, but I meant whether my implied borrowing cost ends up being effectively factored into that, so that the implied borrowing costs gets "deducted" as it would with margin interest.

Thinking about it a bit more... suppose I buy a deep in the money call option that will expire 2 years from now. Let's pretend that the underlying stock does not issue dividends. Imagine that after 1 year the underlying hasn't changed in value. I decide to sell. My call option will have likely decreased in value, since someone buying that option today is effectively getting a loan for a much shorter period of time. So the loss I realize for tax purposes is indeed related to the borrowing costs.
Very insightful. I agree with you. This just made the borrowing costs of derivatives more competitive than I had realized.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 21, 2019 10:00 am

Decided I felt comfortable enough to implement some borrowing with derivatives. For various reasons, I came to the conclusion that options were far superior than futures in my circumstances. Perhaps this thread can be a good resource for others that want to attempt something similar.

I bought 2 Dec 2021 calls on the SPY (strike 295). It cost 5398.02.
I sold 2 Dec 2021 puts on the SPY (strike 295). It credited me with 6253.85.

The expiration date and strike price was chosen after much research and deliberation. I will not bore people with details.

This suddenly increases my exposure by ~58k, getting me basically at my equity target. A drop of 57% would be required for a margin call. Because I will be adding money every 2 weeks to this account from savings contributions, the drop would need to be realistically bigger than that.

This is equivalent to borrowing at ~1.77% for the next 2.5 years.

UberGrub
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Re: Lifecycle Investing - Leveraging when young

Post by UberGrub » Wed Aug 21, 2019 4:19 pm

305pelusa wrote:
Wed Aug 21, 2019 10:00 am
Decided I felt comfortable enough to implement some borrowing with derivatives. For various reasons, I came to the conclusion that options were far superior than futures in my circumstances. Perhaps this thread can be a good resource for others that want to attempt something similar.

I bought 2 Dec 2021 calls on the SPY (strike 295). It cost 5398.02.
I sold 2 Dec 2021 puts on the SPY (strike 295). It credited me with 6253.85.

The expiration date and strike price was chosen after much research and deliberation. I will not bore people with details.

This suddenly increases my exposure by ~58k, getting me basically at my equity target. A drop of 57% would be required for a margin call. Because I will be adding money every 2 weeks to this account from savings contributions, the drop would need to be realistically bigger than that.

This is equivalent to borrowing at ~1.77% for the next 2.5 years.
Long time lurker of the forum and this thread. What you say in this thread makes a lot of sense to me and I am more interested now because you are leveraging with something that is widely available.

Could you explain why options are better than futures here? And how you chose the expiration and strike price? I would be very interested in buying the same options you did, would you recommend this?

Thanks

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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Wed Aug 21, 2019 5:09 pm

305pelusa wrote:
Wed Aug 21, 2019 10:00 am
Decided I felt comfortable enough to implement some borrowing with derivatives. For various reasons, I came to the conclusion that options were far superior than futures in my circumstances. Perhaps this thread can be a good resource for others that want to attempt something similar.

I bought 2 Dec 2021 calls on the SPY (strike 295). It cost 5398.02.
I sold 2 Dec 2021 puts on the SPY (strike 295). It credited me with 6253.85.

The expiration date and strike price was chosen after much research and deliberation. I will not bore people with details.

This suddenly increases my exposure by ~58k, getting me basically at my equity target. A drop of 57% would be required for a margin call. Because I will be adding money every 2 weeks to this account from savings contributions, the drop would need to be realistically bigger than that.

This is equivalent to borrowing at ~1.77% for the next 2.5 years.
Any guess on how much the spread is going to cost you? Like let's say you closed this position immediately, with no change in price, how much would it cost? I ask because when I've looked at LEAPS before it always seemed like there wasn't enough liquidity to make them practical, but maybe you found one where the spread is reasonable?

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 21, 2019 6:06 pm

RandomWord wrote:
Wed Aug 21, 2019 5:09 pm
305pelusa wrote:
Wed Aug 21, 2019 10:00 am
Decided I felt comfortable enough to implement some borrowing with derivatives. For various reasons, I came to the conclusion that options were far superior than futures in my circumstances. Perhaps this thread can be a good resource for others that want to attempt something similar.

I bought 2 Dec 2021 calls on the SPY (strike 295). It cost 5398.02.
I sold 2 Dec 2021 puts on the SPY (strike 295). It credited me with 6253.85.

The expiration date and strike price was chosen after much research and deliberation. I will not bore people with details.

This suddenly increases my exposure by ~58k, getting me basically at my equity target. A drop of 57% would be required for a margin call. Because I will be adding money every 2 weeks to this account from savings contributions, the drop would need to be realistically bigger than that.

This is equivalent to borrowing at ~1.77% for the next 2.5 years.
Any guess on how much the spread is going to cost you? Like let's say you closed this position immediately, with no change in price, how much would it cost? I ask because when I've looked at LEAPS before it always seemed like there wasn't enough liquidity to make them practical, but maybe you found one where the spread is reasonable?
The spread for one call was 35 dollars. The spread for one put was 46. So a combined 81 dollars. So if I bought the two calls and sold the two puts, and immediately undid it, it would cost ((35+46)*2*2) 324 dollars.

You are correct that the spreads on LEAPS (of most maturities) tend to be around that much. The spread on the 1 year LEAP (Sept 2020) was 52 dollars combined (so 208 dollars to do both options and immediately undo it). Not much better.

To be clear, the spread I eat to get into the position is already factored into the implied borrowing cost I calculate. All of my numbers always assumed I had to pay the ask on the calls yet only receive the bids on the puts.

The spread to get out of the position is not incorporated. I have no way of knowing what that will be. It should be much smaller because they will be much more actively traded when it's just a few weeks to expiration.

Even if you assume worst case and that the spread will be that large when I sell these on 2021, it would just be an additional 81*2= 162 dollars to exit. This would bump up the borrowing cost of 58000 from 1.77% to 2.05%. I'm not concerned.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 21, 2019 6:25 pm

UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
Could you explain why options are better than futures here?
Futures require settled cash as collateral. As I came to find out, Schwab pays you basically nothing for that cash (0.3%). IB pays you 1.63%, which is still significantly lower from a MM or high yield savings (not to mention all of the additional fees to use IB). Because I'm looking for conservative leverage, that's a lot of cash (~100k). I could keep the minimum as collateral and keep the rest in a high yield savings and wire every couple of days to meet the many margin calls. That just felt so complicated that I gave up on it.

Naked put collaterals, on the other hand, can be in the form of the ETFs I already own. So my ETFs perform double duty; they are invested and they serve to prove that I'm good for the put's losses. This is far superior
UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
And how you chose the expiration and strike price?
The strike price was chosen because it had a delta of ~1.00, and was vega-neutral. This is key because it maximizes the chances that neither the puts nor the calls become early exercise candidates. I am also not making a statement on volatility this way. As the market veers away from this strike price, these properties will not be maintained. I am positive gamma so if the market rises, I will have a delta higher than 1.00 (and vice-versa). I will also start to be negative vega if the market rises, so increases in volatility would actually create losses too (and vice-versa). However, by achieving neutrality from the get-go, I increase the probability that these second-order effects are insignificant over the coming years.

I knew I wanted an expiration longer than 1 year to get LT CG treatment. At first, I was going to stick to the one year mark (Sept 2020 contracts) because I wanted to minimize the possibility of market conditions changing my vega-neutrality and perfect 1.00 delta. But then I realized the credit I obtain from selling the put and buying the call increases with the longer issues. I don't really know why. But the implication is that the longer issues are the best ones. Their implied borrowing costs are lower regardless of when I exercise/sell.

Theoretically, the spread between the put and call at the same exercise price should be identical independent of the date of expiration (as long as it's on-cycle and barring any dividend shenanigans). But it's not the case here. I conclude there's some volatility skewness (I suspected this earlier in the thread) that is making put writing more profitable than call writing at longer durations. Perhaps this reflects market's risk aversion?

Either way, the longer duration gives me the chance to borrow for longer and is also more profitable in case I want to exit earlier. So I went with it.

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Re: Lifecycle Investing - Leveraging when young

Post by hdas » Wed Aug 21, 2019 9:57 pm

305pelusa wrote:
Wed Aug 21, 2019 6:25 pm
UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
Could you explain why options are better than futures here?
Futures require settled cash as collateral. As I came to find out, Schwab pays you basically nothing for that cash (0.3%). IB pays you 1.63%, which is still significantly lower from a MM or high yield savings (not to mention all of the additional fees to use IB). Because I'm looking for conservative leverage, that's a lot of cash (~100k). I could keep the minimum as collateral and keep the rest in a high yield savings and wire every couple of days to meet the many margin calls. That just felt so complicated that I gave up on it.
This is non sensical. Find an FCM that allows you to post TBills as collateral (usually 95%). If insist on IB, do a realistic VAR analysis and take into account the doubling of margin intraday. Put the excess cash on something like VUSXX, at the end of the day you can sell and be covered if needed.

I wonder, if you can’t figure out this simple thing, how are you going to carry on with the rest of your strategy. Good Luck. :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

rascott
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Re: Lifecycle Investing - Leveraging when young

Post by rascott » Wed Aug 21, 2019 10:22 pm

305pelusa wrote:
Wed Aug 21, 2019 10:00 am
Decided I felt comfortable enough to implement some borrowing with derivatives. For various reasons, I came to the conclusion that options were far superior than futures in my circumstances. Perhaps this thread can be a good resource for others that want to attempt something similar.

I bought 2 Dec 2021 calls on the SPY (strike 295). It cost 5398.02.
I sold 2 Dec 2021 puts on the SPY (strike 295). It credited me with 6253.85.

The expiration date and strike price was chosen after much research and deliberation. I will not bore people with details.

This suddenly increases my exposure by ~58k, getting me basically at my equity target. A drop of 57% would be required for a margin call. Because I will be adding money every 2 weeks to this account from savings contributions, the drop would need to be realistically bigger than that.

This is equivalent to borrowing at ~1.77% for the next 2.5 years.
I'm confused....before you were saying you were buying deep in the money calls (LEAPS), now you are buying at the money (and selling naked puts!)?

This is a much different strategy it seems to me....and much, much higher leverage. Why?

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 21, 2019 10:41 pm

hdas wrote:
Wed Aug 21, 2019 9:57 pm
If insist on IB, do a realistic VAR analysis and take into account the doubling of margin intraday. Put the excess cash on something like VUSXX, at the end of the day you can sell and be covered if needed.
Well that's a terrible suggestion since buying/selling VUSXX would incur some hefty fees at IB. But I understand your point: Keep some cash at IB to keep margin calls at a min and if you get hit by one, liquidate from a MM/High-yield outside IB, or even ST fund like SHV at IB. Personally, I would prefer not having this position be at the risk constant risk of margin calls; I don't want to have to check up on things on a weekly basis to update my cash collateral in case it's running low. Especially since futures are marked-to-market and trade even on Sundays.

Maybe you call that desire "nonsensical". I simply see it as practical.

There's also the concern about taxes which I'll touch upon here:
hdas wrote:
Wed Aug 21, 2019 9:57 pm
Find an FCM that allows you to post TBills as collateral (usually 95%).
I could, yes. I did not look into this much because of the tax drag on the cash position. 100k earning 2% with a marginal bracket of 24% means forfeiting 0.5% in tax costs. I'm looking to borrow 50k-100k at a ~2% rate so making that 2.5% just because the form that my collateral needs to be in didn't seem attractive.

So then I could get cute and keep less in collateral T-bills to minimize that. This creates a conflict where I want to keep enough collateral to minimize the time spent monitoring, but the less I keep the better due to tax drag concerns.
Not to mention I'd have to liquidate some of my ETFs to buy the bills, triggering further taxes.

Considering options allow me to borrow at similar rates, with no commissions at my broker, no mark-to-market, and allowing collateral in the form of my already-owned index ETFs (as tax-efficient as collateral can get), with no need to trigger taxes via liquidation, I decided to opt for the options.
hdas wrote:
Wed Aug 21, 2019 9:57 pm
I wonder, if you can’t figure out this simple thing, how are you going to carry on with the rest of your strategy. Good Luck. :greedy
Overall, I couldn't wrap my head around all of the problems I mentioned above nor could think of ways felt like very clean solutions like I did with options. But I am still open to solutions to them. I look forward to your suggestions :)
And good luck to you as well!

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 21, 2019 10:57 pm

rascott wrote:
Wed Aug 21, 2019 10:22 pm
305pelusa wrote:
Wed Aug 21, 2019 10:00 am
Decided I felt comfortable enough to implement some borrowing with derivatives. For various reasons, I came to the conclusion that options were far superior than futures in my circumstances. Perhaps this thread can be a good resource for others that want to attempt something similar.

I bought 2 Dec 2021 calls on the SPY (strike 295). It cost 5398.02.
I sold 2 Dec 2021 puts on the SPY (strike 295). It credited me with 6253.85.

The expiration date and strike price was chosen after much research and deliberation. I will not bore people with details.

This suddenly increases my exposure by ~58k, getting me basically at my equity target. A drop of 57% would be required for a margin call. Because I will be adding money every 2 weeks to this account from savings contributions, the drop would need to be realistically bigger than that.

This is equivalent to borrowing at ~1.77% for the next 2.5 years.
I'm confused....before you were saying you were buying deep in the money calls (LEAPS), now you are buying at the money (and selling naked puts!)?

This is a much different strategy it seems to me....and much, much higher leverage. Why?
Yeah I can see why that's confusing.

Deep in the money LEAPS (like they advice in the book) are the simpler choice. Because they're so likely to expire in the money, they move in tune with the market (delta of 1.00). There are two issues (one large, one small). The bigger one is because you're buying a call, there is some downside protection associated with the purchase, in addition to the borrowing costs. This brings their costs to around 4%. This is still a good deal for many people, especially those starting out. It's like a non-callable, unsecured loan with downside protection.
The smaller problem is that they have a positive vega. So if volatility increases, they actually rise in price (and vice-versa). I wouldn't want my LEAP to decrease in price near expiration because volatility was low, even though the market was up. I simply don't want to make a stance on volatility. That said, because it's so deep in the money, this effect is small.

In addition to buying a call, you could also sell a put at the same strike price. This eliminates the downside protection, getting you the true borrowing cost (around 1.77%) and making it like a true stock. If the market goes to zero, I bear the full loss (just like if I owned stocks). Once you do that, it actually doesn't matter much what the strike price is. Turns out a strike price of around at-the-money gives you a position of delta 1.00 and vega-neutrality (solving the second problem above)
There are a couple of nuances as far as the strike price to choose that I could go into if you're interested. But that's the general thinking.


The thread has been a little confusing but let's just put it this way: There's two ways to leverage with options:
1) Using calls so in the money that they have 1.00 deltas.
2) Buying some call and selling the same put to create a "synthetic stock". You can google that. It will behave like number 1 but because it has no downside protection, you get to borrow at cheaper rates.

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hdas
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Re: Lifecycle Investing - Leveraging when young

Post by hdas » Wed Aug 21, 2019 11:01 pm

305pelusa wrote:
Wed Aug 21, 2019 10:41 pm

I could, yes. I did not look into this much because of the tax drag on the cash position. 100k earning 2% with a marginal bracket of 24% means forfeiting 0.5% in tax costs. I'm looking to borrow 50k-100k at a ~2% rate so making that 2.5% just because the form that my collateral needs to be in didn't seem attractive
Idk how many trades you’ll be doing but in all your cost analysis you seem to be neglecting the biggest of all and that is the vig in you pay to the market maker for your options.

Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 21, 2019 11:08 pm

hdas wrote:
Wed Aug 21, 2019 11:01 pm
in all your cost analysis you seem to be neglecting the biggest of all and that is the vig in you pay to the market maker for your options.
What makes you say that? Not once in my numbers have I neglected the spread. I just answered a question on this, scroll up to my response to RandomWord.

UberGrub
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Re: Lifecycle Investing - Leveraging when young

Post by UberGrub » Thu Aug 22, 2019 9:01 am

305pelusa wrote:
Wed Aug 21, 2019 6:25 pm
UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
Could you explain why options are better than futures here?
Futures require settled cash as collateral. As I came to find out, Schwab pays you basically nothing for that cash (0.3%). IB pays you 1.63%, which is still significantly lower from a MM or high yield savings (not to mention all of the additional fees to use IB). Because I'm looking for conservative leverage, that's a lot of cash (~100k). I could keep the minimum as collateral and keep the rest in a high yield savings and wire every couple of days to meet the many margin calls. That just felt so complicated that I gave up on it.

Naked put collaterals, on the other hand, can be in the form of the ETFs I already own. So my ETFs perform double duty; they are invested and they serve to prove that I'm good for the put's losses. This is far superior
UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
And how you chose the expiration and strike price?
The strike price was chosen because it had a delta of ~1.00, and was vega-neutral. This is key because it maximizes the chances that neither the puts nor the calls become early exercise candidates. I am also not making a statement on volatility this way. As the market veers away from this strike price, these properties will not be maintained. I am positive gamma so if the market rises, I will have a delta higher than 1.00 (and vice-versa). I will also start to be negative vega if the market rises, so increases in volatility would actually create losses too (and vice-versa). However, by achieving neutrality from the get-go, I increase the probability that these second-order effects are insignificant over the coming years.

I knew I wanted an expiration longer than 1 year to get LT CG treatment. At first, I was going to stick to the one year mark (Sept 2020 contracts) because I wanted to minimize the possibility of market conditions changing my vega-neutrality and perfect 1.00 delta. But then I realized the credit I obtain from selling the put and buying the call increases with the longer issues. I don't really know why. But the implication is that the longer issues are the best ones. Their implied borrowing costs are lower regardless of when I exercise/sell.

Theoretically, the spread between the put and call at the same exercise price should be identical independent of the date of expiration (as long as it's on-cycle and barring any dividend shenanigans). But it's not the case here. I conclude there's some volatility skewness (I suspected this earlier in the thread) that is making put writing more profitable than call writing at longer durations. Perhaps this reflects market's risk aversion?

Either way, the longer duration gives me the chance to borrow for longer and is also more profitable in case I want to exit earlier. So I went with it.
Thank you for the response. The borrowing cost looks very attractive. I applied for option selling on margin from my broker, will know in a couple of days.

It sounds like it's just as simple as finding the strike with Vega of zero and Delta of 1.00 ? You're saying the Dec 2021 are the best choice?

This sounds much simpler to do that the futures, I agree

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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Thu Aug 22, 2019 1:13 pm

hdas wrote:
Wed Aug 21, 2019 9:57 pm
305pelusa wrote:
Wed Aug 21, 2019 6:25 pm
UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
Could you explain why options are better than futures here?
Futures require settled cash as collateral. As I came to find out, Schwab pays you basically nothing for that cash (0.3%). IB pays you 1.63%, which is still significantly lower from a MM or high yield savings (not to mention all of the additional fees to use IB). Because I'm looking for conservative leverage, that's a lot of cash (~100k). I could keep the minimum as collateral and keep the rest in a high yield savings and wire every couple of days to meet the many margin calls. That just felt so complicated that I gave up on it.
This is non sensical. Find an FCM that allows you to post TBills as collateral (usually 95%). If insist on IB, do a realistic VAR analysis and take into account the doubling of margin intraday. Put the excess cash on something like VUSXX, at the end of the day you can sell and be covered if needed.
For what it's worth, IB will let you use regular investments as collateral (can be stocks, bonds, whatever) and then borrow against them on margin as necessary to meet the futures collateral requirements. It's taken care of automatically each day, so you don't have to worry about it. There is a little bit of cash drag, but the collateral requirements on futures are so low that it's minimal, less than 1%.

I think what 305pelusa is doing with options is a lot more complicated than using futures, but the better tax treatment and maybe (?) lower borrowing costs has me intrigued.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Aug 22, 2019 1:50 pm

RandomWord wrote:
Thu Aug 22, 2019 1:13 pm
hdas wrote:
Wed Aug 21, 2019 9:57 pm
305pelusa wrote:
Wed Aug 21, 2019 6:25 pm
UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
Could you explain why options are better than futures here?
Futures require settled cash as collateral. As I came to find out, Schwab pays you basically nothing for that cash (0.3%). IB pays you 1.63%, which is still significantly lower from a MM or high yield savings (not to mention all of the additional fees to use IB). Because I'm looking for conservative leverage, that's a lot of cash (~100k). I could keep the minimum as collateral and keep the rest in a high yield savings and wire every couple of days to meet the many margin calls. That just felt so complicated that I gave up on it.
This is non sensical. Find an FCM that allows you to post TBills as collateral (usually 95%). If insist on IB, do a realistic VAR analysis and take into account the doubling of margin intraday. Put the excess cash on something like VUSXX, at the end of the day you can sell and be covered if needed.
For what it's worth, IB will let you use regular investments as collateral (can be stocks, bonds, whatever) and then borrow against them on margin as necessary to meet the futures collateral requirements. It's taken care of automatically each day, so you don't have to worry about it. There is a little bit of cash drag, but the collateral requirements on futures are so low that it's minimal, less than 1%.

I think what 305pelusa is doing with options is a lot more complicated than using futures, but the better tax treatment and maybe (?) lower borrowing costs has me intrigued.
Yes but doesn't that mean paying margin rates on that cash?

Any ways, the difference really comes down to daily settlement. Futures are like placing a day long bet on the market. At the end of the day, I either provide the cash (either in tax-inneficient cash or by liquidating positions) or I get cash (which I then have to make sure I invest if it's past my cash buffer). This feels like too much time spent

Options aren't daily settled. So gains and losses simply accumulate unrealized. This way, I don't need any cash, don't need to think about liquidating anything to cover cash, nor remember to invest any gains from the position. Towards expiration, I can then liquidate and get the preferable LTCG treatment on the entire thing (instead of paying 60/40 every year for the futures).

I agree the option mechanics themselves are rather complex but I see some major upsides in terms of taxes and day-to-day complexity. Barring major market downturns, this position could be left alone for many months without any checking. That's a huge benefit in my book as well.

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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Thu Aug 22, 2019 3:05 pm

305pelusa wrote:
Thu Aug 22, 2019 1:50 pm
RandomWord wrote:
Thu Aug 22, 2019 1:13 pm
hdas wrote:
Wed Aug 21, 2019 9:57 pm
305pelusa wrote:
Wed Aug 21, 2019 6:25 pm
UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
Could you explain why options are better than futures here?
Futures require settled cash as collateral. As I came to find out, Schwab pays you basically nothing for that cash (0.3%). IB pays you 1.63%, which is still significantly lower from a MM or high yield savings (not to mention all of the additional fees to use IB). Because I'm looking for conservative leverage, that's a lot of cash (~100k). I could keep the minimum as collateral and keep the rest in a high yield savings and wire every couple of days to meet the many margin calls. That just felt so complicated that I gave up on it.
This is non sensical. Find an FCM that allows you to post TBills as collateral (usually 95%). If insist on IB, do a realistic VAR analysis and take into account the doubling of margin intraday. Put the excess cash on something like VUSXX, at the end of the day you can sell and be covered if needed.
For what it's worth, IB will let you use regular investments as collateral (can be stocks, bonds, whatever) and then borrow against them on margin as necessary to meet the futures collateral requirements. It's taken care of automatically each day, so you don't have to worry about it. There is a little bit of cash drag, but the collateral requirements on futures are so low that it's minimal, less than 1%.

I think what 305pelusa is doing with options is a lot more complicated than using futures, but the better tax treatment and maybe (?) lower borrowing costs has me intrigued.
Yes but doesn't that mean paying margin rates on that cash?

Any ways, the difference really comes down to daily settlement. Futures are like placing a day long bet on the market. At the end of the day, I either provide the cash (either in tax-inneficient cash or by liquidating positions) or I get cash (which I then have to make sure I invest if it's past my cash buffer). This feels like too much time spent

Options aren't daily settled. So gains and losses simply accumulate unrealized. This way, I don't need any cash, don't need to think about liquidating anything to cover cash, nor remember to invest any gains from the position. Towards expiration, I can then liquidate and get the preferable LTCG treatment on the entire thing (instead of paying 60/40 every year for the futures).

I agree the option mechanics themselves are rather complex but I see some major upsides in terms of taxes and day-to-day complexity. Barring major market downturns, this position could be left alone for many months without any checking. That's a huge benefit in my book as well.
Yeah you pay margin rates, but you only have to borrow enough to meet the collateral for the futures, which is quite small. I think it's 2% for an S&P e-mini, so you'd be paying margin rate (about 3%) on 2% of your total, for an overall rate of 0.06%. You can stay fully invested in regular stocks, and it just borrows more or pays down the margin loan each day. The only manual effort is if they go up a lot to where you're no longer fully invested, and then you just buy some more. But, yes, the 60/40 tax treatment on futures is annoying.

Maybe you said this before but I missed it- are you just buying stocks, or are you also buying bonds? The SPY options market is quite deep, but I don't know of anything comparable for bonds, at least not for longer than a year out.

RandomWord
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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Thu Aug 22, 2019 4:23 pm

305pelusa wrote:
Wed Aug 21, 2019 10:00 am


This is equivalent to borrowing at ~1.77% for the next 2.5 years.
Also, a basic question. How did you calculate this borrowing cost? And is that fixed, or is that going to change if interest rates change?

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Aug 22, 2019 6:09 pm

RandomWord wrote:
Thu Aug 22, 2019 3:05 pm
Yeah you pay margin rates, but you only have to borrow enough to meet the collateral for the futures, which is quite small. I think it's 2% for an S&P e-mini, so you'd be paying margin rate (about 3%) on 2% of your total, for an overall rate of 0.06%. You can stay fully invested in regular stocks, and it just borrows more or pays down the margin loan each day. The only manual effort is if they go up a lot to where you're no longer fully invested, and then you just buy some more. But, yes, the 60/40 tax treatment on futures is annoying.
This is a neat idea, I hadn't thought of it.
The collateral is 6300 on a contract (notional value of 145k). That's 4.3% for an overall rate of, say, 0.12%
Any ways, I'm not totally certain I'm following. You'd pay margin rate to borrow collateral cash. But if the market keeps creating losses, you have to keep borrowing more and more to replenish the collateral no? So if the market moves down 4.3%, all of your collateral would be wiped out and then you'd borrow another 6300 to replenish it? Now you have 12600 outstanding, which would be a borrowing cost of 0.24%. And so on.

I agree that if the market just goes up and down a little, the margin loans would serve as a little buffer. You'd borrow when needed and pay back with gains. But my concerns are larger market movements. A series of losses would keep racking up more margin debt so you're gonna have to liquidate to pay it back since margin rates are expensive any ways no?
RandomWord wrote:
Thu Aug 22, 2019 3:05 pm

Maybe you said this before but I missed it- are you just buying stocks, or are you also buying bonds? The SPY options market is quite deep, but I don't know of anything comparable for bonds, at least not for longer than a year out.
No bonds. I want to achieve the maximum intertemporal diversification with the minimum amount of borrowing. So the first stop of "borrowing" was to "borrow from myself" by turning any bond holding (money lent to others) into stocks (money lent to myself for investing).

I do recognize the potential of exploiting the term premium however. At some point once I free up some time, I'll look into it.
RandomWord wrote:
Thu Aug 22, 2019 4:23 pm
305pelusa wrote:
Wed Aug 21, 2019 10:00 am


This is equivalent to borrowing at ~1.77% for the next 2.5 years.
Also, a basic question. How did you calculate this borrowing cost? And is that fixed, or is that going to change if interest rates change?
Ben showed me the put-call parity concept back on pages 3 and 4. Very good information if you're interested there. I have shown some numbers back then so I'll just copy a comment where I show an example:
305pelusa wrote:
Fri Jun 21, 2019 10:35 pm

Ben I decided to revisit this concept of put-call parity. I worked out a spreadsheet so I can just plug in the numbers and man these are some pretty phenomenal borrowing rates. I am hoping you could look over my math on this instance just to make sure I got it all right. It's an example with dividends.

SPY current price = 294
LEAPS call with strike 294 in Dec 21, 2021 = 29.63
LEAPS put with strike 294 in Dec 21, 2021 = 29.55
Expected dividend payout of 2%. This means 10 dividend payouts.
Commission of 15 dollars to buy both options and then another 15 to sell them in a few years. So 30/100 = 0.3 dollars.

If I spent 294 and bought the stock until the expiration, then I would end up with 1 SPY position plus 15.43 dollars (that's ten 2% dividends compounded at the T-bill rate of 2.35% with an initial investment of 0.3 dollars, since that's what I "got" by not losing money on option commissions).

So my synthetic call/put/bond position must net that at the end and cost that much at the beginning. That means my bond needs to net 294 + 15.43 = 309.43 by Dec 21, 2021. The bond also needs to cost 294+29.63-29.55= 293.92 today

So now the easy part. Whatever rate dictates a bond goes from 293.92 today to 309.43 by Dec 21, 2021 is my implied borrowing rate. So:
Solve for 293.92*(1+x)^(914/365) = 309.43.
The rate (x) comes out to 2.08%
It can be a little confusing but if you look a little through the thread's pages 3 and 4, you'll see Ben's explanation of this concept. If you need any help with the math, I can probably explain it a little better than that^

The borrowing rate is a great question. It is basically fixed. Notice that the calculation for the borrowing cost depends on the starting and ending prices only. I know what the prices are when I purchased and I know what the prices will be by expiration. So the "costs" of borrowing are essentially fixed in that it's already intrinsic.

A (perhaps simpler) way of seeing this is that the strategy is Rho-positive. Calls increase in value with rates increases (puts vice-versa). So I make money on both the call and the short put with a rate increase. This makes sense because if borrowing costs go up, my position (which gets to borrow at the lower previous, fixed rate) becomes that much more attractive.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Aug 22, 2019 6:59 pm

UberGrub wrote:
Thu Aug 22, 2019 9:01 am
305pelusa wrote:
Wed Aug 21, 2019 6:25 pm
UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
Could you explain why options are better than futures here?
Futures require settled cash as collateral. As I came to find out, Schwab pays you basically nothing for that cash (0.3%). IB pays you 1.63%, which is still significantly lower from a MM or high yield savings (not to mention all of the additional fees to use IB). Because I'm looking for conservative leverage, that's a lot of cash (~100k). I could keep the minimum as collateral and keep the rest in a high yield savings and wire every couple of days to meet the many margin calls. That just felt so complicated that I gave up on it.

Naked put collaterals, on the other hand, can be in the form of the ETFs I already own. So my ETFs perform double duty; they are invested and they serve to prove that I'm good for the put's losses. This is far superior
UberGrub wrote:
Wed Aug 21, 2019 4:19 pm
And how you chose the expiration and strike price?
The strike price was chosen because it had a delta of ~1.00, and was vega-neutral. This is key because it maximizes the chances that neither the puts nor the calls become early exercise candidates. I am also not making a statement on volatility this way. As the market veers away from this strike price, these properties will not be maintained. I am positive gamma so if the market rises, I will have a delta higher than 1.00 (and vice-versa). I will also start to be negative vega if the market rises, so increases in volatility would actually create losses too (and vice-versa). However, by achieving neutrality from the get-go, I increase the probability that these second-order effects are insignificant over the coming years.

I knew I wanted an expiration longer than 1 year to get LT CG treatment. At first, I was going to stick to the one year mark (Sept 2020 contracts) because I wanted to minimize the possibility of market conditions changing my vega-neutrality and perfect 1.00 delta. But then I realized the credit I obtain from selling the put and buying the call increases with the longer issues. I don't really know why. But the implication is that the longer issues are the best ones. Their implied borrowing costs are lower regardless of when I exercise/sell.

Theoretically, the spread between the put and call at the same exercise price should be identical independent of the date of expiration (as long as it's on-cycle and barring any dividend shenanigans). But it's not the case here. I conclude there's some volatility skewness (I suspected this earlier in the thread) that is making put writing more profitable than call writing at longer durations. Perhaps this reflects market's risk aversion?

Either way, the longer duration gives me the chance to borrow for longer and is also more profitable in case I want to exit earlier. So I went with it.
Thank you for the response. The borrowing cost looks very attractive. I applied for option selling on margin from my broker, will know in a couple of days.

It sounds like it's just as simple as finding the strike with Vega of zero and Delta of 1.00 ? You're saying the Dec 2021 are the best choice?

This sounds much simpler to do that the futures, I agree
If you're interested, I recommend you first read through the thread. Understand the concept of the call-put parity, the shortcomings of the American option (and why at-the-money is ideal) and the math for the borrowing cost. Make yourself a little spreadsheet so you can very quickly calculate the borrowing costs of all of the options of a certain maturity.

Here's the process I follow:
1) I copy-paste the greeks info from the following website
https://www.barchart.com/etfs-funds/quo ... ss=allRows

The greek of the position is the greek of the call minus the greek of the puts. I have excel spit out graphs like this one so I can quickly examine how each strike price compares.
Image

Note that Delta of 1.00 is achieved very near 295 (between 297 and 298 to be exact). Higher delta is higher leverage and vice-versa. Note that corresponds to Vega-neutrality. It is slightly negative Theta (this is because there is a borrowing cost). Gamma is positive so Delta will change as the market moves, which means I'll want to keep an eye out from time to time to make sure my purchased position looks reasonable. Finally, it is Rho-positive as I explained to RandomWord.

I picked 295 as it's a more standard number (maybe that helps with future liquidity, idk). But 297/298 is technically the ideal at this point.

2) I then copy-paste the options chain info from here:
https://www.barchart.com/etfs-funds/quotes/SPY/options

And calculate the borrowing costs of all of the options with the appropriate bid/asks. It looks like so:
Image

I highlighted the borrowing costs of strike prices 280-310. You can see they're all basically the same (1.84% right now).

3) The last step is to look at the volume/interest of the strike prices you determine above and pick one.

Hope that helps.

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Re: Lifecycle Investing - Leveraging when young

Post by UberGrub » Fri Aug 23, 2019 8:17 am

@305 Thank you for the information. I read through the thread and kind of understand the logic but the math is over my head right now. I have to sit down and write it out.

I'm very confused by the Greeks and everything you mentioned about early exercise. Is there a book or text you recommend to learn this? Thanks.

RandomWord
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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Fri Aug 23, 2019 1:41 pm

305pelusa wrote:
Thu Aug 22, 2019 6:09 pm
RandomWord wrote:
Thu Aug 22, 2019 3:05 pm
Yeah you pay margin rates, but you only have to borrow enough to meet the collateral for the futures, which is quite small. I think it's 2% for an S&P e-mini, so you'd be paying margin rate (about 3%) on 2% of your total, for an overall rate of 0.06%. You can stay fully invested in regular stocks, and it just borrows more or pays down the margin loan each day. The only manual effort is if they go up a lot to where you're no longer fully invested, and then you just buy some more. But, yes, the 60/40 tax treatment on futures is annoying.
This is a neat idea, I hadn't thought of it.
The collateral is 6300 on a contract (notional value of 145k). That's 4.3% for an overall rate of, say, 0.12%
Any ways, I'm not totally certain I'm following. You'd pay margin rate to borrow collateral cash. But if the market keeps creating losses, you have to keep borrowing more and more to replenish the collateral no? So if the market moves down 4.3%, all of your collateral would be wiped out and then you'd borrow another 6300 to replenish it? Now you have 12600 outstanding, which would be a borrowing cost of 0.24%. And so on.

I agree that if the market just goes up and down a little, the margin loans would serve as a little buffer. You'd borrow when needed and pay back with gains. But my concerns are larger market movements. A series of losses would keep racking up more margin debt so you're gonna have to liquidate to pay it back since margin rates are expensive any ways no?
Yep, that's how it works. That's just... how leverage works, no? If the price moves against you, but you want to keep the same positions open, you have to borrow more because your equity has decreased. Of course you could also sell off some equities to pay down the margin, if that's what you prefer. It's the same whether you're using futures or traditional margin.
I've never traded options- what happens if your position in options moves against you? I'm pretty sure no broker is going to let you rack up losses on the options without making you put up collateral to cover them, somehow. When you buy options there's a limited downside, but you're also selling puts so the downside is unlimited. Or are you only writing covered puts?
305pelusa wrote:
Thu Aug 22, 2019 6:09 pm
RandomWord wrote:
Thu Aug 22, 2019 3:05 pm

Maybe you said this before but I missed it- are you just buying stocks, or are you also buying bonds? The SPY options market is quite deep, but I don't know of anything comparable for bonds, at least not for longer than a year out.
No bonds. I want to achieve the maximum intertemporal diversification with the minimum amount of borrowing. So the first stop of "borrowing" was to "borrow from myself" by turning any bond holding (money lent to others) into stocks (money lent to myself for investing).

I do recognize the potential of exploiting the term premium however. At some point once I free up some time, I'll look into it.
Gotcha. Yeah, I just think it's too risky to leverage 100% stocks, without some bonds to diversify. But admittedly the bonds are a lot harder to leverage.
305pelusa wrote:
Thu Aug 22, 2019 6:09 pm
RandomWord wrote:
Thu Aug 22, 2019 4:23 pm
305pelusa wrote:
Wed Aug 21, 2019 10:00 am


This is equivalent to borrowing at ~1.77% for the next 2.5 years.
Also, a basic question. How did you calculate this borrowing cost? And is that fixed, or is that going to change if interest rates change?
Ben showed me the put-call parity concept back on pages 3 and 4. Very good information if you're interested there. I have shown some numbers back then so I'll just copy a comment where I show an example:
305pelusa wrote:
Fri Jun 21, 2019 10:35 pm

Ben I decided to revisit this concept of put-call parity. I worked out a spreadsheet so I can just plug in the numbers and man these are some pretty phenomenal borrowing rates. I am hoping you could look over my math on this instance just to make sure I got it all right. It's an example with dividends.

SPY current price = 294
LEAPS call with strike 294 in Dec 21, 2021 = 29.63
LEAPS put with strike 294 in Dec 21, 2021 = 29.55
Expected dividend payout of 2%. This means 10 dividend payouts.
Commission of 15 dollars to buy both options and then another 15 to sell them in a few years. So 30/100 = 0.3 dollars.

If I spent 294 and bought the stock until the expiration, then I would end up with 1 SPY position plus 15.43 dollars (that's ten 2% dividends compounded at the T-bill rate of 2.35% with an initial investment of 0.3 dollars, since that's what I "got" by not losing money on option commissions).

So my synthetic call/put/bond position must net that at the end and cost that much at the beginning. That means my bond needs to net 294 + 15.43 = 309.43 by Dec 21, 2021. The bond also needs to cost 294+29.63-29.55= 293.92 today

So now the easy part. Whatever rate dictates a bond goes from 293.92 today to 309.43 by Dec 21, 2021 is my implied borrowing rate. So:
Solve for 293.92*(1+x)^(914/365) = 309.43.
The rate (x) comes out to 2.08%
It can be a little confusing but if you look a little through the thread's pages 3 and 4, you'll see Ben's explanation of this concept. If you need any help with the math, I can probably explain it a little better than that^

The borrowing rate is a great question. It is basically fixed. Notice that the calculation for the borrowing cost depends on the starting and ending prices only. I know what the prices are when I purchased and I know what the prices will be by expiration. So the "costs" of borrowing are essentially fixed in that it's already intrinsic.

A (perhaps simpler) way of seeing this is that the strategy is Rho-positive. Calls increase in value with rates increases (puts vice-versa). So I make money on both the call and the short put with a rate increase. This makes sense because if borrowing costs go up, my position (which gets to borrow at the lower previous, fixed rate) becomes that much more attractive.
OK, after some reading and number crunching I think I'm starting to understand the math. Basically, the greek values of the call/put options cancel out, because of the call/put parity. So you're left with just the cost of missing the dividends, which you can calculate as an implied interest rate. It sounds like, if you take these options and hold them until expiration, the interest rate cost (rho) is completely fixed, because the interest rate won't matter when they're about to expire. So the price of interest is all built into the initial price you paid/received for the options. But if you're buying/selling 2-year options, and then closing them in one year, there's still a lot of rho, so in that case there is some interest rate risk right? Might be good or bad, just depends on how interest rates move. Are you planning to roll the options after a year, or hold them until near expiration?

It still seems a bit weird to me that options can have a single, fixed price of interest, when interest rates are obviously going to change over time. Does this just represent the market's best guess for what they think the average rate of interest will be? You might be taking on some uncompensated interest rate risk here.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Fri Aug 23, 2019 2:08 pm

RandomWord wrote:
Fri Aug 23, 2019 1:41 pm
305pelusa wrote:
Thu Aug 22, 2019 6:09 pm
RandomWord wrote:
Thu Aug 22, 2019 3:05 pm
Yeah you pay margin rates, but you only have to borrow enough to meet the collateral for the futures, which is quite small. I think it's 2% for an S&P e-mini, so you'd be paying margin rate (about 3%) on 2% of your total, for an overall rate of 0.06%. You can stay fully invested in regular stocks, and it just borrows more or pays down the margin loan each day. The only manual effort is if they go up a lot to where you're no longer fully invested, and then you just buy some more. But, yes, the 60/40 tax treatment on futures is annoying.
This is a neat idea, I hadn't thought of it.
The collateral is 6300 on a contract (notional value of 145k). That's 4.3% for an overall rate of, say, 0.12%
Any ways, I'm not totally certain I'm following. You'd pay margin rate to borrow collateral cash. But if the market keeps creating losses, you have to keep borrowing more and more to replenish the collateral no? So if the market moves down 4.3%, all of your collateral would be wiped out and then you'd borrow another 6300 to replenish it? Now you have 12600 outstanding, which would be a borrowing cost of 0.24%. And so on.

I agree that if the market just goes up and down a little, the margin loans would serve as a little buffer. You'd borrow when needed and pay back with gains. But my concerns are larger market movements. A series of losses would keep racking up more margin debt so you're gonna have to liquidate to pay it back since margin rates are expensive any ways no?
Yep, that's how it works. That's just... how leverage works, no? If the price moves against you, but you want to keep the same positions open, you have to borrow more because your equity has decreased. Of course you could also sell off some equities to pay down the margin, if that's what you prefer. It's the same whether you're using futures or traditional margin.
Haha yes you're right. I just thought you were claiming all I'd pay in margin loans would be 0.06%. Could be more or less depending on the market. My misunderstanding.

RandomWord wrote:
Fri Aug 23, 2019 1:41 pm
I've never traded options- what happens if your position in options moves against you? I'm pretty sure no broker is going to let you rack up losses on the options without making you put up collateral to cover them, somehow. When you buy options there's a limited downside, but you're also selling puts so the downside is unlimited. Or are you only writing covered puts?
My puts are neither covered nor cash secured. If the position moves against me, then the call would display an unrealized loss. The put increases in price. This makes it more expensive to buy back. This is also simply displayed as a loss. That loss is calculated assuming I bought it back right now. This is identical to what a short stock position is.

The collateral is in the form of my other ETFs. As long as I have enough dollar amount in my own positions to meet the put margin requirement (20% of underlying + premium - any moneyness), nothing happens. In the case of assignment, my broker knows I have enough securities to liquidate and cover.

A 57% market drop would be necessary before the put margin requirement rises high enough to past my margineable securities. At that point I can either add money to the account/deposit more securities or I'll be forced to buy back the put and realize the loss.
RandomWord wrote:
Fri Aug 23, 2019 1:41 pm
OK, after some reading and number crunching I think I'm starting to understand the math. Basically, the greek values of the call/put options cancel out, because of the call/put parity. So you're left with just the cost of missing the dividends, which you can calculate as an implied interest rate. It sounds like, if you take these options and hold them until expiration, the interest rate cost (rho) is completely fixed, because the interest rate won't matter when they're about to expire. So the price of interest is all built into the initial price you paid/received for the options. But if you're buying/selling 2-year options, and then closing them in one year, there's still a lot of rho, so in that case there is some interest rate risk right? Might be good or bad, just depends on how interest rates move. Are you planning to roll the options after a year, or hold them until near expiration?

It still seems a bit weird to me that options can have a single, fixed price of interest, when interest rates are obviously going to change over time. Does this just represent the market's best guess for what they think the average rate of interest will be? You might be taking on some uncompensated interest rate risk here.
If you sell before expiration, all bets are kind of off. Puts and calls lose time value at different speeds and based on the relationship strike price vs market. If I sell well before expiration, the spread might be quite large. And you're very correct, because my position is positive rho, interest rates would affect me as well.

If you wait until near expiration, all of that is gone and all your left with is the intrinsic value. That's totally independent of everything above. So this is meant to be a buy and hold strategy. Similar to how bonds have no rate risk if you hold to maturity. I am planning on holding onto Dec 2021 if all goes well.

The rate represents the market's carrying cost. It's a similar rate to futures, LIBOR and 3 month bills. If it wasn't, someone could arbitrage it (sell futures and buy a synthetic options position) for profit.

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Re: Lifecycle Investing - Leveraging when young

Post by UberGrub » Fri Aug 23, 2019 6:43 pm

After much lurking, I've decided to go in this strategy. Application was approved. Bought one 288 strike call and sold the equivalent put. Expiration is Dec 2021. I entered for a small credit.

I will see how that goes before adding any more. Thank you for the information 305.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Aug 26, 2019 5:30 pm

UberGrub wrote:
Fri Aug 23, 2019 6:43 pm
After much lurking, I've decided to go in this strategy. Application was approved. Bought one 288 strike call and sold the equivalent put. Expiration is Dec 2021. I entered for a small credit.

I will see how that goes before adding any more. Thank you for the information 305.
Very cool, you're welcome!

Upon a second reading of the book, I realized a huge point I had missed. Social Security. Clearly, this is a very large bond well in my future and should be considered as part of my lifetime wealth.

I have updated my spreadsheet with some estimations of the present value of those future payments and I am once again well under my target. I have enough equity in my accounts that I felt comfortable purchasing two more synthetic positions:

I bought 2 Dec 2021 calls on the SPY (strike 290). It cost 5494.02.
I sold 2 Dec 2021 puts on the SPY (strike 290). It credited me with 6493.85.

This increased my equity exposure by another ~58k. I'm still below my target allocation by more than 100k but I can't comfortably leverage any more than this. I can withstand a market downturn of around 50% without liquidation. This doesn't include the additional savings contributions, which would give me more downside protection. I think this is my personal compromise between attempting to diversify in time as much as possible while staying very far away from forced liquidation.

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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Mon Aug 26, 2019 5:36 pm

So, for those of us following along, what percentage of your position is financed with debt now?

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Aug 26, 2019 5:49 pm

Lee_WSP wrote:
Mon Aug 26, 2019 5:36 pm
So, for those of us following along, what percentage of your position is financed with debt now?
I haven't updated my spreadsheet but it's roughly:
Stock Exposure = 365k
Debt (non-callable) = 101k
Debt (callable) = 112k
Equity in the exposure = 152k
Leverage (counting both forms of debt) = 2.4
Leverage (counting only callable debt) = 1.44

The second leverage number is the more relevant one to figure out liquidation potential.

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Re: Lifecycle Investing - Leveraging when young

Post by hdas » Mon Aug 26, 2019 6:37 pm

305pelusa wrote:
Mon Aug 26, 2019 5:49 pm
Lee_WSP wrote:
Mon Aug 26, 2019 5:36 pm
So, for those of us following along, what percentage of your position is financed with debt now?
I haven't updated my spreadsheet but it's roughly:
Stock Exposure = 365k
Debt (non-callable) = 101k
Debt (callable) = 112k
Equity in the exposure = 152k
Leverage (counting both forms of debt) = 2.4
Leverage (counting only callable debt) = 1.44

The second leverage number is the more relevant one to figure out liquidation potential.
And what are the portfolio holdings? :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Aug 26, 2019 7:31 pm

hdas wrote:
Mon Aug 26, 2019 6:37 pm
305pelusa wrote:
Mon Aug 26, 2019 5:49 pm
Lee_WSP wrote:
Mon Aug 26, 2019 5:36 pm
So, for those of us following along, what percentage of your position is financed with debt now?
I haven't updated my spreadsheet but it's roughly:
Stock Exposure = 365k
Debt (non-callable) = 101k
Debt (callable) = 112k
Equity in the exposure = 152k
Leverage (counting both forms of debt) = 2.4
Leverage (counting only callable debt) = 1.44

The second leverage number is the more relevant one to figure out liquidation potential.
And what are the portfolio holdings? :greedy
Some amount of VTI, VOO, VXUS, VWO, IJS, VSS and VNQ. Plus 4 synthetic stock positions on the SPY with options.

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Re: Lifecycle Investing - Leveraging when young

Post by kfitz1313 » Tue Aug 27, 2019 2:25 am

305pelusa wrote:
Mon Aug 26, 2019 5:49 pm
Lee_WSP wrote:
Mon Aug 26, 2019 5:36 pm
So, for those of us following along, what percentage of your position is financed with debt now?
I haven't updated my spreadsheet but it's roughly:
Stock Exposure = 365k
Debt (non-callable) = 101k
Debt (callable) = 112k
Equity in the exposure = 152k
Leverage (counting both forms of debt) = 2.4
Leverage (counting only callable debt) = 1.44

The second leverage number is the more relevant one to figure out liquidation potential.
Above you noted you can withstand about ~50% drop, but am I correct that it'd be closer to 60% based on needing 25% equity minimum before forced liquidation? I just want to make sure I'm following the math.

112/.75=149.33
365-148.33=215.67
215.67/365=.59 or just under a 60% drop.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Tue Aug 27, 2019 6:46 am

kfitz1313 wrote:
Tue Aug 27, 2019 2:25 am
305pelusa wrote:
Mon Aug 26, 2019 5:49 pm
Lee_WSP wrote:
Mon Aug 26, 2019 5:36 pm
So, for those of us following along, what percentage of your position is financed with debt now?
I haven't updated my spreadsheet but it's roughly:
Stock Exposure = 365k
Debt (non-callable) = 101k
Debt (callable) = 112k
Equity in the exposure = 152k
Leverage (counting both forms of debt) = 2.4
Leverage (counting only callable debt) = 1.44

The second leverage number is the more relevant one to figure out liquidation potential.
Above you noted you can withstand about ~50% drop, but am I correct that it'd be closer to 60% based on needing 25% equity minimum before forced liquidation? I just want to make sure I'm following the math.

112/.75=149.33
365-148.33=215.67
215.67/365=.59 or just under a 60% drop.
Whoah good catch. Math looks correct in general for margin investing.
It will differ from mine for two different reasons:
1) Not all of my stock exposure is in my taxable account where it can be used for collateral. So my true liquidation leverage is actually higher than 1.44 in that sense.
2) My liquidation would come from the relationship of put requirements rising (as markets drop) while my collateral decreases. At some point these two meet.

To make matters a little more confusing, there are multiple equations that could trigger the call. For now I'm held to regulation T and SMA but as the account ages, then Scwhab's equity percent (30%) will be the relevant number. The put requirement calculation is a bit more involved.

Thus far, my way of communicating the above is to say my leverage (ratio of my own money vs exposure) and then also say what a loss I can withstand (by calculating the above requirements). However, these won't be consistent with each other. I'm open to any suggestions in how to portray this information. I just don't know if people care to this level of detail haha.

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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Tue Aug 27, 2019 1:00 pm

305pelusa wrote:
Mon Aug 26, 2019 5:30 pm
UberGrub wrote:
Fri Aug 23, 2019 6:43 pm
After much lurking, I've decided to go in this strategy. Application was approved. Bought one 288 strike call and sold the equivalent put. Expiration is Dec 2021. I entered for a small credit.

I will see how that goes before adding any more. Thank you for the information 305.
Very cool, you're welcome!

Upon a second reading of the book, I realized a huge point I had missed. Social Security. Clearly, this is a very large bond well in my future and should be considered as part of my lifetime wealth.

I have updated my spreadsheet with some estimations of the present value of those future payments and I am once again well under my target. I have enough equity in my accounts that I felt comfortable purchasing two more synthetic positions:

I bought 2 Dec 2021 calls on the SPY (strike 290). It cost 5494.02.
I sold 2 Dec 2021 puts on the SPY (strike 290). It credited me with 6493.85.
Is there any particular reason that you favor SPY over SPX (the index options)? Just curious if that was something you'd considered.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Tue Aug 27, 2019 1:19 pm

RandomWord wrote:
Tue Aug 27, 2019 1:00 pm
305pelusa wrote:
Mon Aug 26, 2019 5:30 pm
UberGrub wrote:
Fri Aug 23, 2019 6:43 pm
After much lurking, I've decided to go in this strategy. Application was approved. Bought one 288 strike call and sold the equivalent put. Expiration is Dec 2021. I entered for a small credit.

I will see how that goes before adding any more. Thank you for the information 305.
Very cool, you're welcome!

Upon a second reading of the book, I realized a huge point I had missed. Social Security. Clearly, this is a very large bond well in my future and should be considered as part of my lifetime wealth.

I have updated my spreadsheet with some estimations of the present value of those future payments and I am once again well under my target. I have enough equity in my accounts that I felt comfortable purchasing two more synthetic positions:

I bought 2 Dec 2021 calls on the SPY (strike 290). It cost 5494.02.
I sold 2 Dec 2021 puts on the SPY (strike 290). It credited me with 6493.85.
Is there any particular reason that you favor SPY over SPX (the index options)? Just curious if that was something you'd considered.
SPY tracks SPX at one tenth the price. If I bought SPX options, one single synthetic would expose me to ~2864*100= 286400 dollars of stocks. That's way above what I need.
I couldn't do it even if I wanted to, since the put requirement would be ~15%*2864 + 30000 = 73k. That collateral is higher than what I have in the Schwab account.

So SPY works well for the investor like myself who just acquired 4 synthetic positions.

Also I think SPX is daily settled. I didn't read much into it but I imagine it would require some cash shenanigans like the futures. You can't just let the gains/losses accumulate unrealized. Don't quote me on that though. I just didn't bother to check completely because they size itself just made them a no-go

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 28, 2019 9:01 am

Looking through the Greeks of the Dec 2021 LEAPs (and also other expirations), it looks like every call under 215 has a Delta of 1 and Gamma of 0. This means the market sees a drop to 21500 in the S&P as a near impossibility. That represents a mere 25% drop.

I'm starting to wonder if I've been too conservative with the worst case drop. While I understand drops bigger than 25% are possible and occur, I'm starting to wonder if it would make more sense to increase leverage (further increasing temporal diversification) since a liquidation is so unlikely to happen.

The human brain has difficulty dealing with very low probabilities. Specifically, we overestimate their likelihood. There are very real diversification advantages to be realized by increasing leverage that I will enjoy in 99.9% of possible futures. Should one really let an extremely unlikely outcome deter from the superior strategy?

I'm open to any thoughts here.

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Re: Lifecycle Investing - Leveraging when young

Post by market timer » Wed Aug 28, 2019 10:41 am

305pelusa wrote:
Wed Aug 28, 2019 9:01 am
Looking through the Greeks of the Dec 2021 LEAPs (and also other expirations), it looks like every call under 215 has a Delta of 1 and Gamma of 0. This means the market sees a drop to 21500 in the S&P as a near impossibility.
The values of the Dec 2021 puts suggest there is a reasonable likelihood we see sub-215 SPY.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 28, 2019 10:52 am

market timer wrote:
Wed Aug 28, 2019 10:41 am
305pelusa wrote:
Wed Aug 28, 2019 9:01 am
Looking through the Greeks of the Dec 2021 LEAPs (and also other expirations), it looks like every call under 215 has a Delta of 1 and Gamma of 0. This means the market sees a drop to 21500 in the S&P as a near impossibility.
The values of the Dec 2021 puts suggest there is a reasonable likelihood we see sub-215 SPY.
Oh yeah you're right. Kinda significant too. Around 20- 25% perhaps.

How can there be such an inconsistency in the call and puts like that? Do you just use whichever is more conservative?

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Re: Lifecycle Investing - Leveraging when young

Post by market timer » Wed Aug 28, 2019 11:00 am

305pelusa wrote:
Wed Aug 28, 2019 10:52 am
market timer wrote:
Wed Aug 28, 2019 10:41 am
305pelusa wrote:
Wed Aug 28, 2019 9:01 am
Looking through the Greeks of the Dec 2021 LEAPs (and also other expirations), it looks like every call under 215 has a Delta of 1 and Gamma of 0. This means the market sees a drop to 21500 in the S&P as a near impossibility.
The values of the Dec 2021 puts suggest there is a reasonable likelihood we see sub-215 SPY.
Oh yeah you're right. Kinda significant too. Around 20- 25% perhaps.

How can there be such an inconsistency in the call and puts like that? Do you just use whichever is more conservative?
In this scenario, I'd trust the puts, since the bid/offer spread is much tighter. There's also potential issues with early exercise on deep-in-the-money calls that would cause put-call parity to break down and perhaps throw off the Greek calculations.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 28, 2019 11:08 am

market timer wrote:
Wed Aug 28, 2019 11:00 am
305pelusa wrote:
Wed Aug 28, 2019 10:52 am
market timer wrote:
Wed Aug 28, 2019 10:41 am
305pelusa wrote:
Wed Aug 28, 2019 9:01 am
Looking through the Greeks of the Dec 2021 LEAPs (and also other expirations), it looks like every call under 215 has a Delta of 1 and Gamma of 0. This means the market sees a drop to 21500 in the S&P as a near impossibility.
The values of the Dec 2021 puts suggest there is a reasonable likelihood we see sub-215 SPY.
Oh yeah you're right. Kinda significant too. Around 20- 25% perhaps.

How can there be such an inconsistency in the call and puts like that? Do you just use whichever is more conservative?
In this scenario, I'd trust the puts, since the bid/offer spread is much tighter. There's also potential issues with early exercise on deep-in-the-money calls that would cause put-call parity to break down and perhaps throw off the Greek calculations.
Fair enough.
Any thoughts on my current strategy of buying a 290-295 call (and selling corresponding put) to obtain leverage? I'm certainly open to hear any thoughts you have about why it's a bad choice/idea.

Thank you very much!

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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Wed Aug 28, 2019 11:14 am

If it's cheaper than buying a future, why hasn't it been arbitraged away? Is there additional risk involved? Longer time factor? Additional transaction costs?

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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Wed Aug 28, 2019 4:36 pm

Lee_WSP wrote:
Wed Aug 28, 2019 11:14 am
If it's cheaper than buying a future, why hasn't it been arbitraged away? Is there additional risk involved? Longer time factor? Additional transaction costs?
Is it actually cheaper? My impression is that the main benefit of options over futures is the better tax treatment, if you're holding for over a year.

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