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).

Lee_WSP
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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?

FIProfessor
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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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305pelusa
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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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