Uncle Fred’s Second Coin – The Case for Leveraged Bonds

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MotoTrojan
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by MotoTrojan » Tue Sep 03, 2019 11:07 am

robertmcd wrote:
Tue Sep 03, 2019 10:10 am
HEDGEFUNDIE wrote:
Sun Sep 01, 2019 10:46 pm
EfficientInvestor wrote:
Sun Sep 01, 2019 10:38 pm
What gets me about EDV (or PEDIX, which has been around since Sep 2006) is that the sharpe ratio has been substantially lower than that of leverage STT since the inception of PEDIX.
Once you decide to play the anti-correlation game, the Sharpe Ratios of individual components are no longer relevant.

The higher volatility of PEDIX would have saved your butt more than leveraged STT during the GFC. Volatility in this case is a feature, not a bug.
Leveraged short term treasuries would have done better than PEDIX during the GFC. Rates dropped much more on the short end of the curve, and the leverage made up for the lack of duration.
How they did during the GFC doesn't say much about the perpetual trend. Also that just means they could rise much more on the short end after the initial drop, no?

robertmcd
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by robertmcd » Tue Sep 03, 2019 11:46 am

MotoTrojan wrote:
Tue Sep 03, 2019 11:07 am
robertmcd wrote:
Tue Sep 03, 2019 10:10 am
HEDGEFUNDIE wrote:
Sun Sep 01, 2019 10:46 pm
EfficientInvestor wrote:
Sun Sep 01, 2019 10:38 pm
What gets me about EDV (or PEDIX, which has been around since Sep 2006) is that the sharpe ratio has been substantially lower than that of leverage STT since the inception of PEDIX.
Once you decide to play the anti-correlation game, the Sharpe Ratios of individual components are no longer relevant.

The higher volatility of PEDIX would have saved your butt more than leveraged STT during the GFC. Volatility in this case is a feature, not a bug.
Leveraged short term treasuries would have done better than PEDIX during the GFC. Rates dropped much more on the short end of the curve, and the leverage made up for the lack of duration.
How they did during the GFC doesn't say much about the perpetual trend. Also that just means they could rise much more on the short end after the initial drop, no?
I agree I was just making a point. Yes there are time when exposure to certain parts of the curve would do better or worse than others. And the Fed funds rate plays a big part in that. If you are not willing to use leverage then that makes the decision much easier to just use TLT or EDV. Depending on equity allocation you can obviously go to 10-30 yrs (VGLT) or 3-10 yrs (VGIT).

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EfficientInvestor
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor » Tue Sep 03, 2019 11:57 am

305pelusa wrote:
Tue Sep 03, 2019 10:57 am
EfficientInvestor wrote:
Fri Aug 30, 2019 2:15 pm
rascott wrote:
Fri Aug 30, 2019 10:29 am
EfficientInvestor wrote:
Fri Aug 30, 2019 6:13 am
coingaroo wrote:
Thu Aug 29, 2019 11:56 pm
If you prefer something buy and hold, leveraged ETFs charge management fees of close to 1%, and is subject to greater volatility decay with daily resets.
Thanks for the reply. You could also consider options. The problem with bond options though is that they are not very liquid. But, if you know what you are doing and are patient, you can get decent fills on ITM call options. If you go deep enough in the money, you don't have too pay much in terms of insurance premium. But, as you go deeper in the money and further out in time, there is less liquidity. The other benefit of options over futures is you can do it with much smaller account sizes. For instance, my wife has a Roth IRA with only $12k in it and we are using options on IEF (7-10 year treasury ETF) in that account. Since it is in a tax advantaged account, I only went out about 6 months for the options contract. If it were not in a tax-advantaged account, I would have tried to get a contract that is at least 1 year out so I could get long term tax treatment (at least in the USA).

I'm confused why you are using IEF over SHY.... when your OP advocates for leveraging 2 yr Treasury?
So I figured I would buy a long-term call today on SHY to see what kind of fill I could get. Current price of the underlying is 85.07. I bought the 1/15/21 contract (504 days) at the 81 strike. I was filled at $4.30 per share ($430 total). The current market price for the put option (cost of insurance) for the same strike is $0.05/share. Therefore, you could say I paid $4.07/share in intrinsic value, $0.05/share in insurance premium, and $0.18/share in cost of carry (interest paid - expected dividend). So to get $8,507 exposure to 2-year treasuries (~20x leverage since I am controlling it with $430), I paid $18 upfront in financing and $5 in insurance. $18/$8,507 = 0.21%. But that is for 504 days. If it were just 365 days, that would maybe have been closer to 0.15%. The current spread between the 3 month treasury (borrow/interest rate) and 2 year treasury (dividend) is -0.477%, so I was actually expecting to have to pay more up front in financing. All in all, I'd say long term contracts on SHY are reasonable if you know what you are doing and don't let yourself get taken advantage of by the wide bid/ask spreads.
I just calculated your implied borrowing costs and it's around 2.7%. I don't think you're taking dividends into account.

Here's how I calculate it (back of the envelope). You paid 4.3 for the right to buy SHY at 81. So what you're borrowing is 81 dollars. You can pay 81 today to get the share, or delay until 2021 so that's the quantity you're being allowed to borrow.

You could buy SHY today for 85. Instead, you're paying 4.3 + all of the dividends (since you won't get them, it's like paying for them). It's around 2.6 in dividends until January 2021. You get to purchase at 81 though. So overall, you'll overpay on this position by 4.3 + 2.6 - 4 (difference between market price and strike) = 2.9. You could buy SHY today for 85 (and get it's dividends), but you're choosing to overpay by 0.3 (extrinsic value of options) AND forfeit dividends instead. So your extra cost is 2.9 effectively.

You'll pay 2.9 bucks to borrow 81 bucks for 16 months. That's 2.9/81*12/16 = 2.68%.

If you don't take dividends into account, it's just 0.3/81*12/16 =0.2%. Which is around what you got.

Anyone feel free to correct me if I'm wrong.
I'm in agreement with your calculation. I guess I was trying to point out that I was taking dividends into account in my cost of carry calculation by saying my "financing" (the $18 paid upfront) was being defined as "interest paid - expected dividends". Whereas your calculation is essentially defining "financing" as being equal to "interest paid", which is the more appropriate definition. I probably made it more confusing than it needed to be (and may have even confused myself) by using the term "financing". I wasn't trying to say that 0.15% was my total borrowing cost, I was just trying to show that my fill price was close to what I would have expected to pay. As you suggested, if you were to add back in the expected dividends into my 0.15% amount, I would be back up near your calculated value of 2.68%.

MotoTrojan
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by MotoTrojan » Tue Sep 03, 2019 12:05 pm

robertmcd wrote:
Tue Sep 03, 2019 11:46 am
MotoTrojan wrote:
Tue Sep 03, 2019 11:07 am
robertmcd wrote:
Tue Sep 03, 2019 10:10 am
HEDGEFUNDIE wrote:
Sun Sep 01, 2019 10:46 pm
EfficientInvestor wrote:
Sun Sep 01, 2019 10:38 pm
What gets me about EDV (or PEDIX, which has been around since Sep 2006) is that the sharpe ratio has been substantially lower than that of leverage STT since the inception of PEDIX.
Once you decide to play the anti-correlation game, the Sharpe Ratios of individual components are no longer relevant.

The higher volatility of PEDIX would have saved your butt more than leveraged STT during the GFC. Volatility in this case is a feature, not a bug.
Leveraged short term treasuries would have done better than PEDIX during the GFC. Rates dropped much more on the short end of the curve, and the leverage made up for the lack of duration.
How they did during the GFC doesn't say much about the perpetual trend. Also that just means they could rise much more on the short end after the initial drop, no?
I agree I was just making a point. Yes there are time when exposure to certain parts of the curve would do better or worse than others. And the Fed funds rate plays a big part in that. If you are not willing to use leverage then that makes the decision much easier to just use TLT or EDV. Depending on equity allocation you can obviously go to 10-30 yrs (VGLT) or 3-10 yrs (VGIT).
Understood. Frankly I am intrigued by the idea of a higher sharpe by leveraging lower durations, but just want to see the backtest and more importantly the rationale for why it is more effective as a counter-balance to equity. To me it seems effective-duration explains the vast majority of the impact.

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305pelusa
Posts: 587
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by 305pelusa » Tue Sep 03, 2019 12:11 pm

EfficientInvestor wrote:
Tue Sep 03, 2019 11:57 am
305pelusa wrote:
Tue Sep 03, 2019 10:57 am
EfficientInvestor wrote:
Fri Aug 30, 2019 2:15 pm
rascott wrote:
Fri Aug 30, 2019 10:29 am
EfficientInvestor wrote:
Fri Aug 30, 2019 6:13 am


Thanks for the reply. You could also consider options. The problem with bond options though is that they are not very liquid. But, if you know what you are doing and are patient, you can get decent fills on ITM call options. If you go deep enough in the money, you don't have too pay much in terms of insurance premium. But, as you go deeper in the money and further out in time, there is less liquidity. The other benefit of options over futures is you can do it with much smaller account sizes. For instance, my wife has a Roth IRA with only $12k in it and we are using options on IEF (7-10 year treasury ETF) in that account. Since it is in a tax advantaged account, I only went out about 6 months for the options contract. If it were not in a tax-advantaged account, I would have tried to get a contract that is at least 1 year out so I could get long term tax treatment (at least in the USA).

I'm confused why you are using IEF over SHY.... when your OP advocates for leveraging 2 yr Treasury?
So I figured I would buy a long-term call today on SHY to see what kind of fill I could get. Current price of the underlying is 85.07. I bought the 1/15/21 contract (504 days) at the 81 strike. I was filled at $4.30 per share ($430 total). The current market price for the put option (cost of insurance) for the same strike is $0.05/share. Therefore, you could say I paid $4.07/share in intrinsic value, $0.05/share in insurance premium, and $0.18/share in cost of carry (interest paid - expected dividend). So to get $8,507 exposure to 2-year treasuries (~20x leverage since I am controlling it with $430), I paid $18 upfront in financing and $5 in insurance. $18/$8,507 = 0.21%. But that is for 504 days. If it were just 365 days, that would maybe have been closer to 0.15%. The current spread between the 3 month treasury (borrow/interest rate) and 2 year treasury (dividend) is -0.477%, so I was actually expecting to have to pay more up front in financing. All in all, I'd say long term contracts on SHY are reasonable if you know what you are doing and don't let yourself get taken advantage of by the wide bid/ask spreads.
I just calculated your implied borrowing costs and it's around 2.7%. I don't think you're taking dividends into account.

Here's how I calculate it (back of the envelope). You paid 4.3 for the right to buy SHY at 81. So what you're borrowing is 81 dollars. You can pay 81 today to get the share, or delay until 2021 so that's the quantity you're being allowed to borrow.

You could buy SHY today for 85. Instead, you're paying 4.3 + all of the dividends (since you won't get them, it's like paying for them). It's around 2.6 in dividends until January 2021. You get to purchase at 81 though. So overall, you'll overpay on this position by 4.3 + 2.6 - 4 (difference between market price and strike) = 2.9. You could buy SHY today for 85 (and get it's dividends), but you're choosing to overpay by 0.3 (extrinsic value of options) AND forfeit dividends instead. So your extra cost is 2.9 effectively.

You'll pay 2.9 bucks to borrow 81 bucks for 16 months. That's 2.9/81*12/16 = 2.68%.

If you don't take dividends into account, it's just 0.3/81*12/16 =0.2%. Which is around what you got.

Anyone feel free to correct me if I'm wrong.
I'm in agreement with your calculation. I guess I was trying to point out that I was taking dividends into account in my cost of carry calculation by saying my "financing" (the $18 paid upfront) was being defined as "interest paid - expected dividends". Whereas your calculation is essentially defining "financing" as being equal to "interest paid", which is the more appropriate definition. I probably made it more confusing than it needed to be (and may have even confused myself) by using the term "financing". I wasn't trying to say that 0.15% was my total borrowing cost, I was just trying to show that my fill price was close to what I would have expected to pay. As you suggested, if you were to add back in the expected dividends into my 0.15% amount, I would be back up near your calculated value of 2.68%.
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/

RandomWord
Posts: 68
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by RandomWord » Tue Sep 03, 2019 12:19 pm

305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 11:57 am
305pelusa wrote:
Tue Sep 03, 2019 10:57 am
EfficientInvestor wrote:
Fri Aug 30, 2019 2:15 pm
rascott wrote:
Fri Aug 30, 2019 10:29 am



I'm confused why you are using IEF over SHY.... when your OP advocates for leveraging 2 yr Treasury?
So I figured I would buy a long-term call today on SHY to see what kind of fill I could get. Current price of the underlying is 85.07. I bought the 1/15/21 contract (504 days) at the 81 strike. I was filled at $4.30 per share ($430 total). The current market price for the put option (cost of insurance) for the same strike is $0.05/share. Therefore, you could say I paid $4.07/share in intrinsic value, $0.05/share in insurance premium, and $0.18/share in cost of carry (interest paid - expected dividend). So to get $8,507 exposure to 2-year treasuries (~20x leverage since I am controlling it with $430), I paid $18 upfront in financing and $5 in insurance. $18/$8,507 = 0.21%. But that is for 504 days. If it were just 365 days, that would maybe have been closer to 0.15%. The current spread between the 3 month treasury (borrow/interest rate) and 2 year treasury (dividend) is -0.477%, so I was actually expecting to have to pay more up front in financing. All in all, I'd say long term contracts on SHY are reasonable if you know what you are doing and don't let yourself get taken advantage of by the wide bid/ask spreads.
I just calculated your implied borrowing costs and it's around 2.7%. I don't think you're taking dividends into account.

Here's how I calculate it (back of the envelope). You paid 4.3 for the right to buy SHY at 81. So what you're borrowing is 81 dollars. You can pay 81 today to get the share, or delay until 2021 so that's the quantity you're being allowed to borrow.

You could buy SHY today for 85. Instead, you're paying 4.3 + all of the dividends (since you won't get them, it's like paying for them). It's around 2.6 in dividends until January 2021. You get to purchase at 81 though. So overall, you'll overpay on this position by 4.3 + 2.6 - 4 (difference between market price and strike) = 2.9. You could buy SHY today for 85 (and get it's dividends), but you're choosing to overpay by 0.3 (extrinsic value of options) AND forfeit dividends instead. So your extra cost is 2.9 effectively.

You'll pay 2.9 bucks to borrow 81 bucks for 16 months. That's 2.9/81*12/16 = 2.68%.

If you don't take dividends into account, it's just 0.3/81*12/16 =0.2%. Which is around what you got.

Anyone feel free to correct me if I'm wrong.
I'm in agreement with your calculation. I guess I was trying to point out that I was taking dividends into account in my cost of carry calculation by saying my "financing" (the $18 paid upfront) was being defined as "interest paid - expected dividends". Whereas your calculation is essentially defining "financing" as being equal to "interest paid", which is the more appropriate definition. I probably made it more confusing than it needed to be (and may have even confused myself) by using the term "financing". I wasn't trying to say that 0.15% was my total borrowing cost, I was just trying to show that my fill price was close to what I would have expected to pay. As you suggested, if you were to add back in the expected dividends into my 0.15% amount, I would be back up near your calculated value of 2.68%.
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Welcome to the wacky world of inverted yields. The reason is basically that people think yields will drop even further. (though, I still think futures are a much better way to invest in leveraged bonds)

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EfficientInvestor
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor » Tue Sep 03, 2019 12:27 pm

305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).

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305pelusa
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by 305pelusa » Tue Sep 03, 2019 12:40 pm

EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?

rascott
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott » Tue Sep 03, 2019 12:55 pm

305pelusa wrote:
Tue Sep 03, 2019 12:40 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?

The history shows that some of the best times to leverage STT is when the curve inverts.... mostly because it tends to always fix itself. Which is kind of contrary to thinking. Regardless, his point is he's maintaining a position regardless of what position the curve looks like at a given time. Which I think is the proper way to do it... and is the opposite of market timing.

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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by ThrustVectoring » Tue Sep 03, 2019 1:05 pm

305pelusa wrote:
Tue Sep 03, 2019 12:40 pm
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?
The fed is expected to cut interest rates in the upcoming months, which would drive the financing costs below the 2-year treasury rate if held through maturity. You're paying more to finance it now, but will likely pay less to finance it later.
Current portfolio: 60% VTI / 40% VXUS

MotoTrojan
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by MotoTrojan » Tue Sep 03, 2019 1:06 pm

EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
Can you help me understand why you feel long-term that leveraging the short-end more than just holding (or more lightly leveraging) the long-end to get the same effective duration? What backtest or philosophy are you using to say this will win-out? Simply that most of the time the yield curve is positive so you will get the spread bonus?

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EfficientInvestor
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor » Tue Sep 03, 2019 1:06 pm

305pelusa wrote:
Tue Sep 03, 2019 12:40 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?
I appreciate what you are saying and I agree that it doesn't make sense when looking at the spread. However, like I said, I am a passive index investor. I am trying to find the best asset to provide diversification to stocks in a passive investing strategy. I think we can all agree that there is a diversification benefit to having bonds in a portfolio. We can all agree that having bonds with longer duration (whether real duration or manufactured with leverage) increases the diversification benefit because you create a second coin that is more equal to the first. My backtest since 1955 (image below) shows that leveraged STT has a higher sharpe ratio than holding unleveraged LTT. Therefore, for my asset allocation, I have chosen to invest in leveraged STT. This decision has nothing to do with current spreads. There have been many times since 1955 when the spread was negative and logic may have said to just hold LTT unleveraged. There may be a way to time this and make an active decision between the two options, but I'm not very interested in that kind of active decision making. Therefore, I am going to stick with what the data is showing me and it shows that leveraged STT has a better sharpe ratio than LTT over the long term.

Image

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305pelusa
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by 305pelusa » Tue Sep 03, 2019 1:12 pm

rascott wrote:
Tue Sep 03, 2019 12:55 pm
305pelusa wrote:
Tue Sep 03, 2019 12:40 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?

The history shows that some of the best times to leverage STT is when the curve inverts.... mostly because it tends to always fix itself. Which is kind of contrary to thinking. Regardless, his point is he's maintaining a position regardless of what position the curve looks like at a given time. Which I think is the proper way to do it... and is the opposite of market timing.
First of all, I don't believe that. What evidence is there of that?

Secondly, just so we're clear, OP can only make money if the curve FURTHER inverts. If it corrects (because ST rates go up), he will lose even more.

rascott
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott » Tue Sep 03, 2019 1:49 pm

305pelusa wrote:
Tue Sep 03, 2019 1:12 pm
rascott wrote:
Tue Sep 03, 2019 12:55 pm
305pelusa wrote:
Tue Sep 03, 2019 12:40 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?

The history shows that some of the best times to leverage STT is when the curve inverts.... mostly because it tends to always fix itself. Which is kind of contrary to thinking. Regardless, his point is he's maintaining a position regardless of what position the curve looks like at a given time. Which I think is the proper way to do it... and is the opposite of market timing.
First of all, I don't believe that. What evidence is there of that?

Secondly, just so we're clear, OP can only make money if the curve FURTHER inverts. If it corrects (because ST rates go up), he will lose even more.
Because an inverted curve typically forecasts a period of lowering interest rates. A 2 yr should yield less than a 10 yr...right now the 2/10 spread is negative.... so if we expect the market to fix itself....the short end of the curve would have a lot more to move down than the long end. At least that's what has happened in the past. It could also fix itself with the long bonds rising in yield.... which would happen if economic headwinds lessen.

Here's some info on last few periods where this has occurred....and you can see how much the 2 yr fell after the inversion (couldn't get the chart to link....but halfway down this article:

https://www.advisorperspectives.com/art ... -started-1


The backtests I ran were based upon quarterly re-positioning...such as you'd find if rolling Treasury futures. Regardless, it makes most sense to me to set your system and stick to it...even if it "looks" like a losing position from the starting gate. If one is going to base their strategy on very long-term results (looking back to 1955, in this example)..... trying to figure out how to jump in/out seems like a recipe to fail.
Last edited by rascott on Tue Sep 03, 2019 1:54 pm, edited 1 time in total.

Topic Author
EfficientInvestor
Posts: 202
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor » Tue Sep 03, 2019 1:51 pm

MotoTrojan wrote:
Tue Sep 03, 2019 1:06 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
Can you help me understand why you feel long-term that leveraging the short-end more than just holding (or more lightly leveraging) the long-end to get the same effective duration? What backtest or philosophy are you using to say this will win-out? Simply that most of the time the yield curve is positive so you will get the spread bonus?
In short, I would say that it is because of the spread bonus. Even though it is negative right now, it should over time average out to a positive. Over time, the rate of return on a 2-year treasury should exceed the risk free rate because of the term risk you are taking on.

Looking at it another way...over the long run (at least since 1955), STT have shown to have higher Sharpe Ratio than LTT. I would expect this trend to continue because as you get closer and closer to the risk-free rate, your Sharpe Ratio should continue to increase because your standard deviation (denominator) should get smaller and smaller until it is zero. When applying leverage, you should be able to maintain that higher Sharpe Ratio as long as your borrow rate is close to the risk-free rate. The one thing that would blow this all up is if the yield curve stayed inverted indefinitely. However, I don't see how this could happen because in the long run because of what I stated in the first paragraph about earning more than the risk-free rate over time due to taking on term risk.

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305pelusa
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by 305pelusa » Tue Sep 03, 2019 1:58 pm

EfficientInvestor wrote:
Tue Sep 03, 2019 1:06 pm
305pelusa wrote:
Tue Sep 03, 2019 12:40 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?
I appreciate what you are saying and I agree that it doesn't make sense when looking at the spread. However, like I said, I am a passive index investor. I am trying to find the best asset to provide diversification to stocks in a passive investing strategy. I think we can all agree that there is a diversification benefit to having bonds in a portfolio. We can all agree that having bonds with longer duration (whether real duration or manufactured with leverage) increases the diversification benefit because you create a second coin that is more equal to the first. My backtest since 1955 (image below) shows that leveraged STT has a higher sharpe ratio than holding unleveraged LTT. Therefore, for my asset allocation, I have chosen to invest in leveraged STT. This decision has nothing to do with current spreads. There have been many times since 1955 when the spread was negative and logic may have said to just hold LTT unleveraged. There may be a way to time this and make an active decision between the two options, but I'm not very interested in that kind of active decision making. Therefore, I am going to stick with what the data is showing me and it shows that leveraged STT has a better sharpe ratio than LTT over the long term.

Image
^ Yes, that is borrowing at CASH rate. The call you bought is costing you quite a bit more than that. 2.7% is not the current risk-free rate.

Also your call has a tiny sliver of time value, barely higher than a dividend. It is most profitably exercised early. You can tell because the put is so cheap. Be aware of that

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EfficientInvestor
Posts: 202
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor » Tue Sep 03, 2019 2:01 pm

305pelusa wrote:
Tue Sep 03, 2019 1:58 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 1:06 pm
305pelusa wrote:
Tue Sep 03, 2019 12:40 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?
I appreciate what you are saying and I agree that it doesn't make sense when looking at the spread. However, like I said, I am a passive index investor. I am trying to find the best asset to provide diversification to stocks in a passive investing strategy. I think we can all agree that there is a diversification benefit to having bonds in a portfolio. We can all agree that having bonds with longer duration (whether real duration or manufactured with leverage) increases the diversification benefit because you create a second coin that is more equal to the first. My backtest since 1955 (image below) shows that leveraged STT has a higher sharpe ratio than holding unleveraged LTT. Therefore, for my asset allocation, I have chosen to invest in leveraged STT. This decision has nothing to do with current spreads. There have been many times since 1955 when the spread was negative and logic may have said to just hold LTT unleveraged. There may be a way to time this and make an active decision between the two options, but I'm not very interested in that kind of active decision making. Therefore, I am going to stick with what the data is showing me and it shows that leveraged STT has a better sharpe ratio than LTT over the long term.

Image
^ Yes, that is borrowing at CASH rate. The call you bought is costing you quite a bit more than that. 2.7% is not the current risk-free rate.

Also your call has a tiny sliver of time value, barely higher than a dividend. It is most profitably exercised early. You can tell because the put is so cheap. Be aware of that
I am primarily using futures contracts to implement the strategy. I only bought the SHY call to test out the kind of fill I could get so I could see how close to CASH rates I could get.

rascott
Posts: 708
Joined: Wed Apr 15, 2015 10:53 am

Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott » Tue Sep 03, 2019 2:11 pm

305pelusa wrote:
Tue Sep 03, 2019 1:58 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 1:06 pm
305pelusa wrote:
Tue Sep 03, 2019 12:40 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm
305pelusa wrote:
Tue Sep 03, 2019 12:11 pm
I guess the part I'm confused about is why you'd borrow at 2.7% to invest in a security worse only growth is 2.1%. You're investing in bonds with -0.6% returns. This hardly seems like an Uncle Fred's second toss :/
Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?
I appreciate what you are saying and I agree that it doesn't make sense when looking at the spread. However, like I said, I am a passive index investor. I am trying to find the best asset to provide diversification to stocks in a passive investing strategy. I think we can all agree that there is a diversification benefit to having bonds in a portfolio. We can all agree that having bonds with longer duration (whether real duration or manufactured with leverage) increases the diversification benefit because you create a second coin that is more equal to the first. My backtest since 1955 (image below) shows that leveraged STT has a higher sharpe ratio than holding unleveraged LTT. Therefore, for my asset allocation, I have chosen to invest in leveraged STT. This decision has nothing to do with current spreads. There have been many times since 1955 when the spread was negative and logic may have said to just hold LTT unleveraged. There may be a way to time this and make an active decision between the two options, but I'm not very interested in that kind of active decision making. Therefore, I am going to stick with what the data is showing me and it shows that leveraged STT has a better sharpe ratio than LTT over the long term.

Image
^ Yes, that is borrowing at CASH rate. The call you bought is costing you quite a bit more than that. 2.7% is not the current risk-free rate.

Also your call has a tiny sliver of time value, barely higher than a dividend. It is most profitably exercised early. You can tell because the put is so cheap. Be aware of that
He also bought a very long-dated call (2021 I believe)....with basically zero volume. So don't think that's a good example of the overall strategy.

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305pelusa
Posts: 587
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Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by 305pelusa » Tue Sep 03, 2019 2:19 pm

EfficientInvestor wrote:
Tue Sep 03, 2019 2:01 pm
305pelusa wrote:
Tue Sep 03, 2019 1:58 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 1:06 pm
305pelusa wrote:
Tue Sep 03, 2019 12:40 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 12:27 pm


Because I'm not making my investing decisions based on what the current spread looks like. Like any good Boglehead, I'm choosing a strategy and staying the course. Though my use of leverage may be counter to many Boglehead views, I am still very much a passive index investor that does not try to time the market (whether it be stock or bond market). I agree that the inverted yield curve is a bit of a head-wind against the second coin at the moment, but that is just the nature of using leveraged short term bonds. Just because it is inverted doesn't mean you should stop implementing the strategy. My second coin could still just as easily flip heads in this inverted situation (e.g. if the Fed cuts rates again).
It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?
I appreciate what you are saying and I agree that it doesn't make sense when looking at the spread. However, like I said, I am a passive index investor. I am trying to find the best asset to provide diversification to stocks in a passive investing strategy. I think we can all agree that there is a diversification benefit to having bonds in a portfolio. We can all agree that having bonds with longer duration (whether real duration or manufactured with leverage) increases the diversification benefit because you create a second coin that is more equal to the first. My backtest since 1955 (image below) shows that leveraged STT has a higher sharpe ratio than holding unleveraged LTT. Therefore, for my asset allocation, I have chosen to invest in leveraged STT. This decision has nothing to do with current spreads. There have been many times since 1955 when the spread was negative and logic may have said to just hold LTT unleveraged. There may be a way to time this and make an active decision between the two options, but I'm not very interested in that kind of active decision making. Therefore, I am going to stick with what the data is showing me and it shows that leveraged STT has a better sharpe ratio than LTT over the long term.

Image
^ Yes, that is borrowing at CASH rate. The call you bought is costing you quite a bit more than that. 2.7% is not the current risk-free rate.

Also your call has a tiny sliver of time value, barely higher than a dividend. It is most profitably exercised early. You can tell because the put is so cheap. Be aware of that
I am primarily using futures contracts to implement the strategy. I only bought the SHY call to test out the kind of fill I could get so I could see how close to CASH rates I could get.
Ah I see. It was curiosity more than profitability, should've sad that before haha. I've been trying to argue that rate is no good this entire time.

So what rates can you get with futures?

Topic Author
EfficientInvestor
Posts: 202
Joined: Thu Nov 01, 2018 7:02 pm

Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor » Tue Sep 03, 2019 3:26 pm

305pelusa wrote:
Tue Sep 03, 2019 2:19 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 2:01 pm
305pelusa wrote:
Tue Sep 03, 2019 1:58 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 1:06 pm
305pelusa wrote:
Tue Sep 03, 2019 12:40 pm


It might just be a nomenclature thing then. Your position only makes money if rates drop. To me, that's the ultimate level in speculation and market timing. It's a bet on future rate movement; if they don't drop enough, you lose money. If they drop a little, stay the same, or go up, you lose money.

If you calculate the Sharpe ratio of your position, it's negative. How is this Boglehead in any way?
I appreciate what you are saying and I agree that it doesn't make sense when looking at the spread. However, like I said, I am a passive index investor. I am trying to find the best asset to provide diversification to stocks in a passive investing strategy. I think we can all agree that there is a diversification benefit to having bonds in a portfolio. We can all agree that having bonds with longer duration (whether real duration or manufactured with leverage) increases the diversification benefit because you create a second coin that is more equal to the first. My backtest since 1955 (image below) shows that leveraged STT has a higher sharpe ratio than holding unleveraged LTT. Therefore, for my asset allocation, I have chosen to invest in leveraged STT. This decision has nothing to do with current spreads. There have been many times since 1955 when the spread was negative and logic may have said to just hold LTT unleveraged. There may be a way to time this and make an active decision between the two options, but I'm not very interested in that kind of active decision making. Therefore, I am going to stick with what the data is showing me and it shows that leveraged STT has a better sharpe ratio than LTT over the long term.

Image
^ Yes, that is borrowing at CASH rate. The call you bought is costing you quite a bit more than that. 2.7% is not the current risk-free rate.

Also your call has a tiny sliver of time value, barely higher than a dividend. It is most profitably exercised early. You can tell because the put is so cheap. Be aware of that
I am primarily using futures contracts to implement the strategy. I only bought the SHY call to test out the kind of fill I could get so I could see how close to CASH rates I could get.
Ah I see. It was curiosity more than profitability, should've sad that before haha. I've been trying to argue that rate is no good this entire time.

So what rates can you get with futures?
Generally, the risk-free rate. You can view the 10 year performance of rolling 2-year futures at this link:
https://us.spindices.com/indices/fixed- ... turn-index

SHY has the same 1.11% annualized return over the time period. In other words, by using futures, there weren't any additional financing cost drags that led you to not get the same returns as SHY. In some years, futures roll rich/cheap and you will underperform/overperform SHY. Over the long term (at least over the last 10 years), this affect evens out. I believe the s&p index assumes that the futures contract is fully backed by cash that is earning the risk-free rate (and offsetting the risk-free rate that you are getting charged in the futures contract).

rascott
Posts: 708
Joined: Wed Apr 15, 2015 10:53 am

Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott » Tue Sep 03, 2019 5:41 pm

EfficientInvestor wrote:
Tue Sep 03, 2019 3:26 pm
305pelusa wrote:
Tue Sep 03, 2019 2:19 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 2:01 pm
305pelusa wrote:
Tue Sep 03, 2019 1:58 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 1:06 pm


I appreciate what you are saying and I agree that it doesn't make sense when looking at the spread. However, like I said, I am a passive index investor. I am trying to find the best asset to provide diversification to stocks in a passive investing strategy. I think we can all agree that there is a diversification benefit to having bonds in a portfolio. We can all agree that having bonds with longer duration (whether real duration or manufactured with leverage) increases the diversification benefit because you create a second coin that is more equal to the first. My backtest since 1955 (image below) shows that leveraged STT has a higher sharpe ratio than holding unleveraged LTT. Therefore, for my asset allocation, I have chosen to invest in leveraged STT. This decision has nothing to do with current spreads. There have been many times since 1955 when the spread was negative and logic may have said to just hold LTT unleveraged. There may be a way to time this and make an active decision between the two options, but I'm not very interested in that kind of active decision making. Therefore, I am going to stick with what the data is showing me and it shows that leveraged STT has a better sharpe ratio than LTT over the long term.

Image
^ Yes, that is borrowing at CASH rate. The call you bought is costing you quite a bit more than that. 2.7% is not the current risk-free rate.

Also your call has a tiny sliver of time value, barely higher than a dividend. It is most profitably exercised early. You can tell because the put is so cheap. Be aware of that
I am primarily using futures contracts to implement the strategy. I only bought the SHY call to test out the kind of fill I could get so I could see how close to CASH rates I could get.
Ah I see. It was curiosity more than profitability, should've sad that before haha. I've been trying to argue that rate is no good this entire time.

So what rates can you get with futures?
Generally, the risk-free rate. You can view the 10 year performance of rolling 2-year futures at this link:
https://us.spindices.com/indices/fixed- ... turn-index

SHY has the same 1.11% annualized return over the time period. In other words, by using futures, there weren't any additional financing cost drags that led you to not get the same returns as SHY. In some years, futures roll rich/cheap and you will underperform/overperform SHY. Over the long term (at least over the last 10 years), this affect evens out. I believe the s&p index assumes that the futures contract is fully backed by cash that is earning the risk-free rate (and offsetting the risk-free rate that you are getting charged in the futures contract).
I believe Treasury futures basically get the overnight repo rate....so more or less the Fed Funds rate, no?

Topic Author
EfficientInvestor
Posts: 202
Joined: Thu Nov 01, 2018 7:02 pm

Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor » Tue Sep 03, 2019 7:40 pm

rascott wrote:
Tue Sep 03, 2019 5:41 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 3:26 pm
305pelusa wrote:
Tue Sep 03, 2019 2:19 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 2:01 pm
305pelusa wrote:
Tue Sep 03, 2019 1:58 pm

^ Yes, that is borrowing at CASH rate. The call you bought is costing you quite a bit more than that. 2.7% is not the current risk-free rate.

Also your call has a tiny sliver of time value, barely higher than a dividend. It is most profitably exercised early. You can tell because the put is so cheap. Be aware of that
I am primarily using futures contracts to implement the strategy. I only bought the SHY call to test out the kind of fill I could get so I could see how close to CASH rates I could get.
Ah I see. It was curiosity more than profitability, should've sad that before haha. I've been trying to argue that rate is no good this entire time.

So what rates can you get with futures?
Generally, the risk-free rate. You can view the 10 year performance of rolling 2-year futures at this link:
https://us.spindices.com/indices/fixed- ... turn-index

SHY has the same 1.11% annualized return over the time period. In other words, by using futures, there weren't any additional financing cost drags that led you to not get the same returns as SHY. In some years, futures roll rich/cheap and you will underperform/overperform SHY. Over the long term (at least over the last 10 years), this affect evens out. I believe the s&p index assumes that the futures contract is fully backed by cash that is earning the risk-free rate (and offsetting the risk-free rate that you are getting charged in the futures contract).
I believe Treasury futures basically get the overnight repo rate....so more or less the Fed Funds rate, no?
Futures use the LIBOR, which historically is slightly above the fed fund rate. I believe the 3-month T-bill can also be used as an approximation if you want data going further back in time.

CME has an Equity Quarterly Roll Analyzer Tool (link below) that shows the effective cost of rolling from one contract to the next and how it compares to the LIBOR rate.

https://www.cmegroup.com/trading/equity ... /main.html

rascott
Posts: 708
Joined: Wed Apr 15, 2015 10:53 am

Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott » Wed Sep 04, 2019 1:05 pm

EfficientInvestor wrote:
Tue Sep 03, 2019 7:40 pm
rascott wrote:
Tue Sep 03, 2019 5:41 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 3:26 pm
305pelusa wrote:
Tue Sep 03, 2019 2:19 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 2:01 pm


I am primarily using futures contracts to implement the strategy. I only bought the SHY call to test out the kind of fill I could get so I could see how close to CASH rates I could get.
Ah I see. It was curiosity more than profitability, should've sad that before haha. I've been trying to argue that rate is no good this entire time.

So what rates can you get with futures?
Generally, the risk-free rate. You can view the 10 year performance of rolling 2-year futures at this link:
https://us.spindices.com/indices/fixed- ... turn-index

SHY has the same 1.11% annualized return over the time period. In other words, by using futures, there weren't any additional financing cost drags that led you to not get the same returns as SHY. In some years, futures roll rich/cheap and you will underperform/overperform SHY. Over the long term (at least over the last 10 years), this affect evens out. I believe the s&p index assumes that the futures contract is fully backed by cash that is earning the risk-free rate (and offsetting the risk-free rate that you are getting charged in the futures contract).
I believe Treasury futures basically get the overnight repo rate....so more or less the Fed Funds rate, no?
Futures use the LIBOR, which historically is slightly above the fed fund rate. I believe the 3-month T-bill can also be used as an approximation if you want data going further back in time.

CME has an Equity Quarterly Roll Analyzer Tool (link below) that shows the effective cost of rolling from one contract to the next and how it compares to the LIBOR rate.

https://www.cmegroup.com/trading/equity ... /main.html

Well, that shows a rate a bit lower than the current Fed Funds rate... which is still 2.25?

Topic Author
EfficientInvestor
Posts: 202
Joined: Thu Nov 01, 2018 7:02 pm

Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by EfficientInvestor » Wed Sep 04, 2019 1:30 pm

rascott wrote:
Wed Sep 04, 2019 1:05 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 7:40 pm
rascott wrote:
Tue Sep 03, 2019 5:41 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 3:26 pm
305pelusa wrote:
Tue Sep 03, 2019 2:19 pm


Ah I see. It was curiosity more than profitability, should've sad that before haha. I've been trying to argue that rate is no good this entire time.

So what rates can you get with futures?
Generally, the risk-free rate. You can view the 10 year performance of rolling 2-year futures at this link:
https://us.spindices.com/indices/fixed- ... turn-index

SHY has the same 1.11% annualized return over the time period. In other words, by using futures, there weren't any additional financing cost drags that led you to not get the same returns as SHY. In some years, futures roll rich/cheap and you will underperform/overperform SHY. Over the long term (at least over the last 10 years), this affect evens out. I believe the s&p index assumes that the futures contract is fully backed by cash that is earning the risk-free rate (and offsetting the risk-free rate that you are getting charged in the futures contract).
I believe Treasury futures basically get the overnight repo rate....so more or less the Fed Funds rate, no?
Futures use the LIBOR, which historically is slightly above the fed fund rate. I believe the 3-month T-bill can also be used as an approximation if you want data going further back in time.

CME has an Equity Quarterly Roll Analyzer Tool (link below) that shows the effective cost of rolling from one contract to the next and how it compares to the LIBOR rate.

https://www.cmegroup.com/trading/equity ... /main.html

Well, that shows a rate a bit lower than the current Fed Funds rate... which is still 2.25?
Effective Fund Rate is currently 2.13

https://fred.stlouisfed.org/series/DFF

rascott
Posts: 708
Joined: Wed Apr 15, 2015 10:53 am

Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott » Wed Sep 04, 2019 1:57 pm

EfficientInvestor wrote:
Wed Sep 04, 2019 1:30 pm
rascott wrote:
Wed Sep 04, 2019 1:05 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 7:40 pm
rascott wrote:
Tue Sep 03, 2019 5:41 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 3:26 pm


Generally, the risk-free rate. You can view the 10 year performance of rolling 2-year futures at this link:
https://us.spindices.com/indices/fixed- ... turn-index

SHY has the same 1.11% annualized return over the time period. In other words, by using futures, there weren't any additional financing cost drags that led you to not get the same returns as SHY. In some years, futures roll rich/cheap and you will underperform/overperform SHY. Over the long term (at least over the last 10 years), this affect evens out. I believe the s&p index assumes that the futures contract is fully backed by cash that is earning the risk-free rate (and offsetting the risk-free rate that you are getting charged in the futures contract).
I believe Treasury futures basically get the overnight repo rate....so more or less the Fed Funds rate, no?
Futures use the LIBOR, which historically is slightly above the fed fund rate. I believe the 3-month T-bill can also be used as an approximation if you want data going further back in time.

CME has an Equity Quarterly Roll Analyzer Tool (link below) that shows the effective cost of rolling from one contract to the next and how it compares to the LIBOR rate.

https://www.cmegroup.com/trading/equity ... /main.html

Well, that shows a rate a bit lower than the current Fed Funds rate... which is still 2.25?
Effective Fund Rate is currently 2.13

https://fred.stlouisfed.org/series/DFF
Ok... so basically identical to the FFR currently...I thought I had read in the CME material that the cost of carry was roughly the FFR. But there are times where it diverts....

RandomWord
Posts: 68
Joined: Tue Jun 18, 2019 1:12 pm

Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by RandomWord » Wed Sep 04, 2019 3:26 pm

rascott wrote:
Wed Sep 04, 2019 1:57 pm
EfficientInvestor wrote:
Wed Sep 04, 2019 1:30 pm
rascott wrote:
Wed Sep 04, 2019 1:05 pm
EfficientInvestor wrote:
Tue Sep 03, 2019 7:40 pm
rascott wrote:
Tue Sep 03, 2019 5:41 pm


I believe Treasury futures basically get the overnight repo rate....so more or less the Fed Funds rate, no?
Futures use the LIBOR, which historically is slightly above the fed fund rate. I believe the 3-month T-bill can also be used as an approximation if you want data going further back in time.

CME has an Equity Quarterly Roll Analyzer Tool (link below) that shows the effective cost of rolling from one contract to the next and how it compares to the LIBOR rate.

https://www.cmegroup.com/trading/equity ... /main.html

Well, that shows a rate a bit lower than the current Fed Funds rate... which is still 2.25?
Effective Fund Rate is currently 2.13

https://fred.stlouisfed.org/series/DFF
Ok... so basically identical to the FFR currently...I thought I had read in the CME material that the cost of carry was roughly the FFR. But there are times where it diverts....
Is anyone else thinking, like me, that it would be a whole lot easier if we could just borrow money directly from the fed instead of messing around with derivatives?

rascott
Posts: 708
Joined: Wed Apr 15, 2015 10:53 am

Re: Uncle Fred’s Second Coin – The Case for Leveraged Bonds

Post by rascott » Wed Sep 11, 2019 11:44 am

So I set up a paper account at TDA/TOS to mess with these futures.

$100k hypothetical portfolio

Desired exposure:

100% SP500
1200% 2- year Treasury

Bought 6 /ZT Dec Futures for $1.2m notional exposure (actually more, due to the current price of 107.. so I guess closer to $1.3m... pls correct if that's wrong)

$73k SPY
$10k UPRO
= $103k SP500 exposure (roughly) (SPY@$299)


This left me $16k roughly in cash sweep to cover margin on the futures. Looking back this is likely too conservative with the cash...1% is roughly the max drawdown on STTs, historically, so $12k would have been more than enough, and could have bought much less UPRO. Also could have just used a Micro E- mini... but wanted to isolate the futures to the STT for this little test run, just to observe their behavior.

The 2 year was at roughly 1.68% when I opened the position..... bought /ZT at 107'210.

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