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 » Wed Aug 28, 2019 5:36 pm

RandomWord wrote:
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.
I'm going off my recollection of his reasoning earlier in this thread. I could be wrong.

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Re: Lifecycle Investing - Leveraging when young

Post by market timer » Wed Aug 28, 2019 7:31 pm

305pelusa wrote:
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!
Seems like a reasonable choice to me. The only thing missing from your analysis is tax treatment. Assuming your investment is profitable, you'll end up incurring short term capital gains on the short puts and long term capital gains on the calls. Depending on your tax bracket, this could be a material consideration. The higher the strike you choose, the larger share of your gains will be treated as short term capital gains.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Aug 28, 2019 9:45 pm

market timer wrote:
Wed Aug 28, 2019 7:31 pm
305pelusa wrote:
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

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!
Seems like a reasonable choice to me. The only thing missing from your analysis is tax treatment. Assuming your investment is profitable, you'll end up incurring short term capital gains on the short puts and long term capital gains on the calls. Depending on your tax bracket, this could be a material consideration. The higher the strike you choose, the larger share of your gains will be treated as short term capital gains.
Yes, certainly something to consider. Taxes are something I integrate in the equity risk premium of the Samuelson share calculation. Obviously I can't predict it exactly but it's accounted for to some extent.

Thanks for the help!
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?
I think they're pretty similar in borrowing costs. Some times I found options to be cheaper, some times futures were.
RandomWord wrote:
Wed Aug 28, 2019 4:36 pm

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.
The biggest benefit for me was that collateral was allowed in the form of margineable securities instead of actual cash. I don't want to hold cash, pay taxes on cash returns, nor try to figure out the least amount of cash I can hold to prevent sudden liquidation. With the options, I just hold them and gains/losses stay unrealized. I find this easier to manage and don't spend much time thinking about it since they were set up. Some find this nonsensical but I find it easier I suppose.

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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Thu Aug 29, 2019 12:23 pm

market timer wrote:
Wed Aug 28, 2019 7:31 pm
305pelusa wrote:
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

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!
Seems like a reasonable choice to me. The only thing missing from your analysis is tax treatment. Assuming your investment is profitable, you'll end up incurring short term capital gains on the short puts and long term capital gains on the calls. Depending on your tax bracket, this could be a material consideration. The higher the strike you choose, the larger share of your gains will be treated as short term capital gains.
Why would he get short term capital gains on the short puts? Is that assuming he never buys them back and they expire un-exercised?

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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Thu Aug 29, 2019 2:29 pm

IIRC, exercised option costs are rolled into the purchased asset's cost basis. Unsure about this, but since the asset purchase would negate the option, it seems like the click would start all over again.

If the options are rolled, the worthless one would be a loss, the valuable one would be cap gains.

RandomWord
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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Thu Aug 29, 2019 3:14 pm

Lee_WSP wrote:
Thu Aug 29, 2019 2:29 pm
IIRC, exercised option costs are rolled into the purchased asset's cost basis. Unsure about this, but since the asset purchase would negate the option, it seems like the click would start all over again.

If the options are rolled, the worthless one would be a loss, the valuable one would be cap gains.
Well, it's the short-term part that confuses me. Why would they be short-term cap gains if held for more than a year?

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Aug 29, 2019 3:17 pm

RandomWord wrote:
Thu Aug 29, 2019 12:23 pm
market timer wrote:
Wed Aug 28, 2019 7:31 pm
305pelusa wrote:
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


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!
Seems like a reasonable choice to me. The only thing missing from your analysis is tax treatment. Assuming your investment is profitable, you'll end up incurring short term capital gains on the short puts and long term capital gains on the calls. Depending on your tax bracket, this could be a material consideration. The higher the strike you choose, the larger share of your gains will be treated as short term capital gains.
Why would he get short term capital gains on the short puts? Is that assuming he never buys them back and they expire un-exercised?
Unexercised or closed out short option gains are always STCG. Intuitively, I think it's because the gains/credit from them was already received on the day you opened the position. There's no "gain" you're holding onto for extended periods of time. Whatever you can gain out of it you do from day one. The biggest profit is that you buy it back for no money.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Aug 29, 2019 3:25 pm

RandomWord wrote:
Thu Aug 29, 2019 3:14 pm
Lee_WSP wrote:
Thu Aug 29, 2019 2:29 pm
IIRC, exercised option costs are rolled into the purchased asset's cost basis. Unsure about this, but since the asset purchase would negate the option, it seems like the click would start all over again.

If the options are rolled, the worthless one would be a loss, the valuable one would be cap gains.
Well, it's the short-term part that confuses me. Why would they be short-term cap gains if held for more than a year?
BTW, the proportion of ST (puts) and LT (call) depends on the index price at expiration and the premiums. If S&P is at 2980, it's all ST. Any additional gain above that is LT (from the call).

I expect SPY to hit ~312 by expiration so I estimate around 12% of the gains would be ST and the rest LT. Anything lower and the ST proportion would be larger. Anything higher... You get the idea

It's just an expectation of course. We'll see what happens haha.

RandomWord
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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Thu Aug 29, 2019 4:15 pm

305pelusa wrote:
Thu Aug 29, 2019 3:17 pm
RandomWord wrote:
Thu Aug 29, 2019 12:23 pm
market timer wrote:
Wed Aug 28, 2019 7:31 pm
305pelusa wrote:
Wed Aug 28, 2019 11:08 am
market timer wrote:
Wed Aug 28, 2019 11:00 am

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!
Seems like a reasonable choice to me. The only thing missing from your analysis is tax treatment. Assuming your investment is profitable, you'll end up incurring short term capital gains on the short puts and long term capital gains on the calls. Depending on your tax bracket, this could be a material consideration. The higher the strike you choose, the larger share of your gains will be treated as short term capital gains.
Why would he get short term capital gains on the short puts? Is that assuming he never buys them back and they expire un-exercised?
Unexercised or closed out short option gains are always STCG. Intuitively, I think it's because the gains/credit from them was already received on the day you opened the position. There's no "gain" you're holding onto for extended periods of time. Whatever you can gain out of it you do from day one. The biggest profit is that you buy it back for no money.
Ah ok, that's annoying but I guess it makes sense.

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Re: Lifecycle Investing - Leveraging when young

Post by Lee_WSP » Thu Aug 29, 2019 6:09 pm

RandomWord wrote:
Thu Aug 29, 2019 3:14 pm
Lee_WSP wrote:
Thu Aug 29, 2019 2:29 pm
IIRC, exercised option costs are rolled into the purchased asset's cost basis. Unsure about this, but since the asset purchase would negate the option, it seems like the click would start all over again.

If the options are rolled, the worthless one would be a loss, the valuable one would be cap gains.
Well, it's the short-term part that confuses me. Why would they be short-term cap gains if held for more than a year?
If you sell the option before expiration and after holding it for > 1 year, then I cannot see why it would still be a short term cap gain. However, if you convert it, IIRC, it is rolled into the cost basis since you didn't sell it, therefore there is no taxable event. That's my understanding anyway. I could be wrong. Feel free to double check this.

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Re: Lifecycle Investing - Leveraging when young

Post by market timer » Thu Aug 29, 2019 7:57 pm

305pelusa wrote:
Thu Aug 29, 2019 3:25 pm
RandomWord wrote:
Thu Aug 29, 2019 3:14 pm
Lee_WSP wrote:
Thu Aug 29, 2019 2:29 pm
IIRC, exercised option costs are rolled into the purchased asset's cost basis. Unsure about this, but since the asset purchase would negate the option, it seems like the click would start all over again.

If the options are rolled, the worthless one would be a loss, the valuable one would be cap gains.
Well, it's the short-term part that confuses me. Why would they be short-term cap gains if held for more than a year?
BTW, the proportion of ST (puts) and LT (call) depends on the index price at expiration and the premiums. If S&P is at 2980, it's all ST. Any additional gain above that is LT (from the call).

I expect SPY to hit ~312 by expiration so I estimate around 12% of the gains would be ST and the rest LT. Anything lower and the ST proportion would be larger. Anything higher... You get the idea

It's just an expectation of course. We'll see what happens haha.
I'm getting different numbers from you. If SPY is at 312 in Dec 2021, and assuming you bought a 290 call and sold a 290 put (both for $30), you'd have a $30 gain on the put (treated as a STCG) and an $8 loss on the call. For typical market returns (middle of the bell curve), most--if not all--of your profits will come from the short put and receive unfavorable tax treatment if you construct a synthetic long using near-the-money options. That's why I suggested considering tax implications in your choice of strike. The lower your strike price, the greater share of gains that should come from the call, and receive favorable tax treatment. In my view, this should be the key determinant of choice of strike price. You seemed to focus on vega neutrality, but any synthetic long should have "close enough" vega neutrality, assuming the LEAP call is not so deep in-the-money that it will be exercised early in the next few months.

One other idea to consider is to buy SPY calls and sell put options on S&P e-mini futures. This would give you 60/40 LTCG/STCG tax treatment on the put option. For far out-of-the-money options, the collateral requirements should not change much week-to-week, mitigating the need to monitor your cash position.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Aug 29, 2019 8:27 pm

market timer wrote:
Thu Aug 29, 2019 7:57 pm
305pelusa wrote:
Thu Aug 29, 2019 3:25 pm
RandomWord wrote:
Thu Aug 29, 2019 3:14 pm
Lee_WSP wrote:
Thu Aug 29, 2019 2:29 pm
IIRC, exercised option costs are rolled into the purchased asset's cost basis. Unsure about this, but since the asset purchase would negate the option, it seems like the click would start all over again.

If the options are rolled, the worthless one would be a loss, the valuable one would be cap gains.
Well, it's the short-term part that confuses me. Why would they be short-term cap gains if held for more than a year?
BTW, the proportion of ST (puts) and LT (call) depends on the index price at expiration and the premiums. If S&P is at 2980, it's all ST. Any additional gain above that is LT (from the call).

I expect SPY to hit ~312 by expiration so I estimate around 12% of the gains would be ST and the rest LT. Anything lower and the ST proportion would be larger. Anything higher... You get the idea

It's just an expectation of course. We'll see what happens haha.
I'm getting different numbers from you. If SPY is at 312 in Dec 2021, and assuming you bought a 290 call and sold a 290 put (both for $30), you'd have a $30 gain on the put (treated as a STCG) and an $8 loss on the call. For typical market returns (middle of the bell curve), most--if not all--of your profits will come from the short put and receive unfavorable tax treatment if you construct a synthetic long using near-the-money options. That's why I suggested considering tax implications in your choice of strike. The lower your strike price, the greater share of gains that should come from the call, and receive favorable tax treatment. In my view, this should be the key determinant of choice of strike price. You seemed to focus on vega neutrality, but any synthetic long should have "close enough" vega neutrality, assuming the LEAP call is not so deep in-the-money that it will be exercised early in the next few months.

One other idea to consider is to buy SPY calls and sell put options on S&P e-mini futures. This would give you 60/40 LTCG/STCG tax treatment on the put option. For far out-of-the-money options, the collateral requirements should not change much week-to-week, mitigating the need to monitor your cash position.
Ah yes I was off by a decimal on that. That certainly tips the tax scales towards futures or using e-mini puts.

My concern was not vega-neutrality as much as early assignment. Perhaps those fears were overstated. I'll see how it goes over the coming 2 years. Hopefully the thread can be useful to others who would like to try similar things though.

Thank you very much for your help man.

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Re: Lifecycle Investing - Leveraging when young

Post by Zilvervloot » Fri Aug 30, 2019 3:47 am

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.
Dear Pelusa,
Thank you for this great topic. I noticed that the rate is 1,77% and lower than previously mentioned values. Is that due to the profit you made from above transaction? Another question: what is the liquidity for dec 2021 call and puts. I see large bid-ask spreads and low volumes: https://www.barchart.com/etfs-funds/quo ... 2021-12-17

kfitz1313
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Re: Lifecycle Investing - Leveraging when young

Post by kfitz1313 » Fri Aug 30, 2019 4:26 am

Credit cards were mentioned earlier as a possible borrowing method. Obviously, they have high interest, but I've been thinking about one method around this. Many cards have large sign-up bonuses (Chase gives $750 when spending $3,000 on the Sapphire Reserve) in the 10-30% range. If you couple this with something like M1 Borrow or another low interest portfolio loan, you could pretty easily borrow for free. M1 will let you borrow 35% of your taxable account. If you had $100K, you could then put $35K onto these higher tier credit cards and pay them off with M1 at 4.25% interest.

Chase Sapphire Reserve - $750 reward for $3,000 spend
Chase Ink Preferred - $1200 reward for $5,000 spend
Chase Ink Cash - $500 reward for $3,000 spend
Amex Platinum - $1,200 reward for $5,000 spend
Amex Gold - $700 reward for $2,000 spend

Those are all just ballpark based on experience and The Points Guy. You can see that you could spend $18,000 with those five cards and reap $4,350. That's roughly a 24% return. If that was all you did, you would pay $765 the first year by using M1 at the current 4.25% interest. If rates stay the same, you basically get to borrow the $18,000 for free for over 5.5 years. Naturally, there are issues with scaling this strategy, but it could allow you to turn a great deal of your everyday spending into cheap loans. Rather than actually paying for your groceries out of pocket, leave the money in the portfolio, and add that cheap debt to your overall leverage. Let me know if I'm missing something with this.

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Re: Lifecycle Investing - Leveraging when young

Post by rmelvey » Fri Aug 30, 2019 5:32 am

kfitz1313 wrote:
Fri Aug 30, 2019 4:26 am
Credit cards were mentioned earlier as a possible borrowing method. Obviously, they have high interest, but I've been thinking about one method around this. Many cards have large sign-up bonuses (Chase gives $750 when spending $3,000 on the Sapphire Reserve) in the 10-30% range. If you couple this with something like M1 Borrow or another low interest portfolio loan, you could pretty easily borrow for free. M1 will let you borrow 35% of your taxable account. If you had $100K, you could then put $35K onto these higher tier credit cards and pay them off with M1 at 4.25% interest.

Chase Sapphire Reserve - $750 reward for $3,000 spend
Chase Ink Preferred - $1200 reward for $5,000 spend
Chase Ink Cash - $500 reward for $3,000 spend
Amex Platinum - $1,200 reward for $5,000 spend
Amex Gold - $700 reward for $2,000 spend

Those are all just ballpark based on experience and The Points Guy. You can see that you could spend $18,000 with those five cards and reap $4,350. That's roughly a 24% return. If that was all you did, you would pay $765 the first year by using M1 at the current 4.25% interest. If rates stay the same, you basically get to borrow the $18,000 for free for over 5.5 years. Naturally, there are issues with scaling this strategy, but it could allow you to turn a great deal of your everyday spending into cheap loans. Rather than actually paying for your groceries out of pocket, leave the money in the portfolio, and add that cheap debt to your overall leverage. Let me know if I'm missing something with this.
I have been experimenting with using zero interest credit cards for my every day spend, and investing the difference. It works fine but it definitely hurts your credit score due to the credit utilization %. So if you do go on this path you can only do it for a limited period of time because eventually you won't get accepted for new cards.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Fri Aug 30, 2019 8:17 am

Zilvervloot wrote:
Fri Aug 30, 2019 3:47 am
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.
Dear Pelusa,
Thank you for this great topic. I noticed that the rate is 1,77% and lower than previously mentioned values. Is that due to the profit you made from above transaction? Another question: what is the liquidity for dec 2021 call and puts. I see large bid-ask spreads and low volumes: https://www.barchart.com/etfs-funds/quo ... 2021-12-17
The 1.77% includes that credit I incurred. I always did in my calculations. I've noticed it tends to hover around 1.78% at this expiration and strike price.

The liquidity is low on these options. To me, it just means these aren't meant to be traded around a lot. I haven't thought too much about the liquidity since I always incorporated the spread in the implied rate and I'm looking to hold until expiration any ways.

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Re: Lifecycle Investing - Leveraging when young

Post by Zilvervloot » Fri Aug 30, 2019 10:13 am

Thanks for the answer. This is quite interesting, since this rate is even lower than the rate for the E-mini S&P rate, which hovers around the 3 months Libor, which is at the moment is 2,1%! See also https://www.cmegroup.com/trading/equity ... -etfs.html
And for the futures you also have rolling costs. Wonder if there is a catch...

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Fri Aug 30, 2019 10:42 am

Zilvervloot wrote:
Fri Aug 30, 2019 10:13 am
Thanks for the answer. This is quite interesting, since this rate is even lower than the rate for the E-mini S&P rate, which hovers around the 3 months Libor, which is at the moment is 2,1%! See also https://www.cmegroup.com/trading/equity ... -etfs.html
And for the futures you also have rolling costs. Wonder if there is a catch...
You'll want to take taxes into account, which is very individual. Interestingly enough, the lower the strike price, the lower the taxes (in general) but also the higher the borrowing cost (without including taxes). Updating my spreadsheet with taxes yesterday, I find that the strike prices I picked were marginally superior in terms of total costs (including taxes). Going to a strike price of, say 220 (as low as I'd be willing to go), makes around 60% of the gains LT (if it meets the return expectation I have), but does bump up the implied borrowing rate to ~2.3%.

So the strike price choice seemed to be a bit of a wash except that the ATM minimizes the possibility of early exercise. I'm happy with those.

I mention this because if futures show a borrowing rate of 2.1% (I'm taking your word on this) and treated at 60/40, they're actually very similar to the 220 options I mentioned above. And hence, all taxes considered, would be similar to the options I currently hold as well. Again, this is for my specific tax circumstances.

It looks like futures might be slightly better for most folks in terms of costs but it's a close race.

RandomWord
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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Mon Sep 02, 2019 9:06 pm

305pelusa wrote:
Fri Aug 30, 2019 10:42 am
Zilvervloot wrote:
Fri Aug 30, 2019 10:13 am
Thanks for the answer. This is quite interesting, since this rate is even lower than the rate for the E-mini S&P rate, which hovers around the 3 months Libor, which is at the moment is 2,1%! See also https://www.cmegroup.com/trading/equity ... -etfs.html
And for the futures you also have rolling costs. Wonder if there is a catch...
You'll want to take taxes into account, which is very individual. Interestingly enough, the lower the strike price, the lower the taxes (in general) but also the higher the borrowing cost (without including taxes). Updating my spreadsheet with taxes yesterday, I find that the strike prices I picked were marginally superior in terms of total costs (including taxes). Going to a strike price of, say 220 (as low as I'd be willing to go), makes around 60% of the gains LT (if it meets the return expectation I have), but does bump up the implied borrowing rate to ~2.3%.

So the strike price choice seemed to be a bit of a wash except that the ATM minimizes the possibility of early exercise. I'm happy with those.

I mention this because if futures show a borrowing rate of 2.1% (I'm taking your word on this) and treated at 60/40, they're actually very similar to the 220 options I mentioned above. And hence, all taxes considered, would be similar to the options I currently hold as well. Again, this is for my specific tax circumstances.

It looks like futures might be slightly better for most folks in terms of costs but it's a close race.
For what it's worth, CME publishes a tool that shows the implied financing cost of equity futures at roll time:
https://www.cmegroup.com/trading/equity ... /main.html
It does indeed show that the implied financing rate for an S&P e-mini is 2.13% right now. Interestingly, the other equity futures have a slightly lower rate (1.99 for nasdaq, 1.92 for russell 2000).

I still think it's an important difference that with your buy-and-hold LEAPS approach the borrowing cost is fixed, whereas with futures it's going to fluctuate every day, and the difference will directly affect your account balance.

Zilvervloot
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Re: Lifecycle Investing - Leveraging when young

Post by Zilvervloot » Thu Sep 05, 2019 7:22 am

For those who invest internationally, European futures might be interesting. Libor for the Euro is negative at the moment making financing costs quite low. The Eurostoxx 50 future (the European equivalent of the S&P 500) has quite low financing cost of around 1,0 to 1,5%.
E.g. the dec future trades at 3461 giving a discount of 18 points to the index of 3479. Taking into account a dividend of 3,5% (and around 40 points per quarterly future) this leads to an implied financing rate of 1,4%. Problem is that dividends are not always distributed quarterly in Europe, so if dividends are mostly distributed in the first half year you overestimate the implied financing rate.

Back to the options, do I understand correctly that for those without capital gains taxes, it is better to chose a higher strike price for the call/put option pair?

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Re: Lifecycle Investing - Leveraging when young

Post by JuniorRob » Thu Sep 05, 2019 7:41 am

Holding a mortgage is leveraging when young.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Sep 05, 2019 8:18 am

Zilvervloot wrote:
Thu Sep 05, 2019 7:22 am
For those who invest internationally, European futures might be interesting. Libor for the Euro is negative at the moment making financing costs quite low. The Eurostoxx 50 future (the European equivalent of the S&P 500) has quite low financing cost of around 1,0 to 1,5%.
E.g. the dec future trades at 3461 giving a discount of 18 points to the index of 3479. Taking into account a dividend of 3,5% (and around 40 points per quarterly future) this leads to an implied financing rate of 1,4%. Problem is that dividends are not always distributed quarterly in Europe, so if dividends are mostly distributed in the first half year you overestimate the implied financing rate.

Back to the options, do I understand correctly that for those without capital gains taxes, it is better to chose a higher strike price for the call/put option pair?
Umh interesting. Certainly something I'll have to look into.

If you don't have CG taxes, the higher strike prices seem to be strictly superior. But why wouldn't you have capital gains taxes? Recall that you cannot sell uncovered, unsecured puts in a retirement account like IRAs or 401ks.

techcrium
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Re: Lifecycle Investing - Leveraging when young

Post by techcrium » Thu Sep 05, 2019 8:42 am

Hey I just want to say I did a form of this in 2013.

My thread if you want to browse:
viewtopic.php?f=1&t=131230

At the time I had $100K in equity and I was $200K in assets. $30K in 0% credit card interest which I would repay and renew each year. $30K in margin (rates were only 4% at the time). $40K in a personal loan at 3% interest.


As of now, my networth is around $650,000 but I was lucky as the stock market went nowhere but up over the last years.


I am asking you guys here, since I have $650,000 in equity, should I continue to be levered 2:1 and thus I should be buying $1.3million in stocks??

I am currently 31 and I was 25 in 2013

(My actual situation is that I have $700,000 in equities and thus $50,000 leverage. I have been slowly deleveraging as my friend has been slowly recalling their loan. Current margin rates for me are 5.5% and I calculated it is not worth that risk)

techcrium
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Re: Lifecycle Investing - Leveraging when young

Post by techcrium » Thu Sep 05, 2019 9:08 am

Adding to Lifecycle Investing....

Has anyone thought about incorporating family into this leverage?

Say your parents or grandparents are about to retire with a $2million portfolio and they can't handle risk and are probably 90% bonds or something.

What if you insure them their annual withdrawal rate (via your savings when market crashes) and convince them to go 100% stocks?

I guess this is essentially a family loan where you pay them a fixed percentage each year...

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Re: Lifecycle Investing - Leveraging when young

Post by Zilvervloot » Thu Sep 05, 2019 9:19 am


Umh interesting. Certainly something I'll have to look into.

If you don't have CG taxes, the higher strike prices seem to be strictly superior. But why wouldn't you have capital gains taxes? Recall that you cannot sell uncovered, unsecured puts in a retirement account like IRAs or 401ks.
Sorry, forgot to mention that I am not US based.

techcrium
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Re: Lifecycle Investing - Leveraging when young

Post by techcrium » Thu Sep 05, 2019 2:17 pm

305pelusa wrote:
Wed Aug 07, 2019 6:42 pm

It's about reward for your efforts. I find that applying for a new card takes ~15 minutes. Then instead of putting expenses onto my previous card, I put them onto the newer card (no extra effort there). I don't spend much so I feel very confident I can fully pay it off by funneling my saving contributions 3 months before expiration. So instead of investing the money (buying ETFs), I pay the card. That's actually easier than submitting purchase orders.

And that's the entire process. It doesn't make a big difference but I do know it takes me virtually zero effort. So it's a freebie in my book. I can see it is enormously challenging to others, so clearly, it is not for them.


The cash advance (like the balance transfers) are worth consideration at 3% rates. Anything sub 3.5% begins to be potentially worthwhile for this strategy. It's clearly not as good as just racking expenses monthly on the card (which, while not fully exploiting the promotional rate, does not pay the 3% at all in the first place), but up there nonetheless. It's not that the cash advances and transfers are terrible; the promotional rate of 0% over a year is just that good.

Regardless, I agree CCs are not suitable as a sustainable form of leverage. They're low-hanging fruit if you can work with it but you won't miss out much if you forego them.
I think you are getting into a philosophical discussion of what is "work" and whether churning credit cards is "free money" or not because usually:

-Read through the fine print on promotional terms (15-20 minutes)
-You need to apply for a credit card (15 minutes)
-Take a credit hit on your rating
-Get it mailed/activate it (15 minutes)
-Sometimes they require you to go to the branch to activate it (30-45 minutes)
-Reroute all your monthly obligation payments to this new credit card (e.g. netflix, amazon, utilities, internet)
-Add the new credit card to your bank account as a payee
-Remember to delete the old credit card from other obligations (e.g. netflix, amazon, utilities, internet)
-Remember the new credit card payment deadline and not forget to pay it
-Hope that you don't mispay your dozens of credit cards

All that for a potential $200-$300 in rewards. Is it worth it? Some say yes, some say no.


The promotional cash advance is not much different than the lines above.


This is coming from a guy who has churned lots and lots of credit cards.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Sep 05, 2019 4:16 pm

techcrium wrote:
Thu Sep 05, 2019 2:17 pm
305pelusa wrote:
Wed Aug 07, 2019 6:42 pm

It's about reward for your efforts. I find that applying for a new card takes ~15 minutes. Then instead of putting expenses onto my previous card, I put them onto the newer card (no extra effort there). I don't spend much so I feel very confident I can fully pay it off by funneling my saving contributions 3 months before expiration. So instead of investing the money (buying ETFs), I pay the card. That's actually easier than submitting purchase orders.

And that's the entire process. It doesn't make a big difference but I do know it takes me virtually zero effort. So it's a freebie in my book. I can see it is enormously challenging to others, so clearly, it is not for them.


The cash advance (like the balance transfers) are worth consideration at 3% rates. Anything sub 3.5% begins to be potentially worthwhile for this strategy. It's clearly not as good as just racking expenses monthly on the card (which, while not fully exploiting the promotional rate, does not pay the 3% at all in the first place), but up there nonetheless. It's not that the cash advances and transfers are terrible; the promotional rate of 0% over a year is just that good.

Regardless, I agree CCs are not suitable as a sustainable form of leverage. They're low-hanging fruit if you can work with it but you won't miss out much if you forego them.
I think you are getting into a philosophical discussion of what is "work" and whether churning credit cards is "free money" or not because usually:

-Read through the fine print on promotional terms (15-20 minutes)
-You need to apply for a credit card (15 minutes)
-Take a credit hit on your rating
-Get it mailed/activate it (15 minutes)
-Sometimes they require you to go to the branch to activate it (30-45 minutes)
-Reroute all your monthly obligation payments to this new credit card (e.g. netflix, amazon, utilities, internet)
-Add the new credit card to your bank account as a payee
-Remember to delete the old credit card from other obligations (e.g. netflix, amazon, utilities, internet)
-Remember the new credit card payment deadline and not forget to pay it
-Hope that you don't mispay your dozens of credit cards

All that for a potential $200-$300 in rewards. Is it worth it? Some say yes, some say no.


The promotional cash advance is not much different than the lines above.


This is coming from a guy who has churned lots and lots of credit cards.
I've never had to go to a branch for activations. And I don't forward previous payments to the new card either. The bulk of my expenses are food, gas, travel and entertainment where it takes me 0 extra minutes to pay it with card A than card B. There's no payments to make due to 0% APR.

But even if I humor you and agree you'd have to do all of those things, we're talking about ~200 bucks for 2 hours of easy work. That's 100 bucks per hour. That's an excellent return for my time (at this point in my life at least).

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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest » Mon Sep 09, 2019 3:27 am

305pelusa wrote:
Mon Aug 05, 2019 5:03 pm
...
- Leveraged ETFs: These ETFs borrow at the LIBOR rate (and even lower). When you factor in the hefty expense ratio, they begin to have similar costs to using futures (perhaps a little more expensive). These reset the leverage daily to achieve 2:1 leverage between every trading day. This makes these extremely susceptible to volatility decay but clearly superior during trending markets.
Can you please elaborate how LETFs can borrow below LIBOR rate, and what the evidence that they do so?

Also, "When you factor in the hefty expense ratio, they begin to have similar costs..." - I think LETFs use mostly futures, right? If so, the expense ratio would be on top of the expenses intrinsic to the futures.

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Re: Lifecycle Investing - Leveraging when young

Post by HEDGEFUNDIE » Mon Sep 09, 2019 6:11 am

comeinvest wrote:
Mon Sep 09, 2019 3:27 am
305pelusa wrote:
Mon Aug 05, 2019 5:03 pm
...
- Leveraged ETFs: These ETFs borrow at the LIBOR rate (and even lower). When you factor in the hefty expense ratio, they begin to have similar costs to using futures (perhaps a little more expensive). These reset the leverage daily to achieve 2:1 leverage between every trading day. This makes these extremely susceptible to volatility decay but clearly superior during trending markets.
Can you please elaborate how LETFs can borrow below LIBOR rate, and what the evidence that they do so?
See viewtopic.php?p=4397820#p4397820 and viewtopic.php?p=4397820#p4397853

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Sep 09, 2019 4:21 pm

comeinvest wrote:
Mon Sep 09, 2019 3:27 am
305pelusa wrote:
Mon Aug 05, 2019 5:03 pm
...
- Leveraged ETFs: These ETFs borrow at the LIBOR rate (and even lower). When you factor in the hefty expense ratio, they begin to have similar costs to using futures (perhaps a little more expensive). These reset the leverage daily to achieve 2:1 leverage between every trading day. This makes these extremely susceptible to volatility decay but clearly superior during trending markets.
Can you please elaborate how LETFs can borrow below LIBOR rate, and what the evidence that they do so?

Also, "When you factor in the hefty expense ratio, they begin to have similar costs..." - I think LETFs use mostly futures, right? If so, the expense ratio would be on top of the expenses intrinsic to the futures.
In retrospect, that sentence you quoted of mine is wrong in the context of this thread. UPRO generally seems to borrow at or slightly higher than the LIBOR. And then you'd have the high expenses on top of that. Taxes aside, futures would be significantly cheaper

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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest » Mon Sep 09, 2019 11:58 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.

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
Can you cite an example of an FCM that allows T-Bills, or any other equity positions, as futures collateral? I asked a few, but have not been able to find one. Thanks!
Last edited by comeinvest on Tue Sep 10, 2019 2:42 am, edited 1 time in total.

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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest » Tue Sep 10, 2019 2:33 am

Zilvervloot wrote:
Thu Sep 05, 2019 7:22 am
For those who invest internationally, European futures might be interesting. Libor for the Euro is negative at the moment making financing costs quite low. The Eurostoxx 50 future (the European equivalent of the S&P 500) has quite low financing cost of around 1,0 to 1,5%.
E.g. the dec future trades at 3461 giving a discount of 18 points to the index of 3479. Taking into account a dividend of 3,5% (and around 40 points per quarterly future) this leads to an implied financing rate of 1,4%. Problem is that dividends are not always distributed quarterly in Europe, so if dividends are mostly distributed in the first half year you overestimate the implied financing rate.

Back to the options, do I understand correctly that for those without capital gains taxes, it is better to chose a higher strike price for the call/put option pair?
I think something must be wrong with your math as well as with your logic. Short-term risk-free rates in Europe are -0.5% or even less if I'm not mistaken. An implied financing rate of 1.4% would be ca. 2% above the risk-free rate and therefore a very bad deal. I believe your dividend estimate is far off.

Unfortunately I have not found any source for expected dividends, or for implied financing rates on Eurex futures.

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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest » Tue Sep 10, 2019 3:08 am

HEDGEFUNDIE wrote:
Mon Sep 09, 2019 6:11 am
comeinvest wrote:
Mon Sep 09, 2019 3:27 am
305pelusa wrote:
Mon Aug 05, 2019 5:03 pm
...
- Leveraged ETFs: These ETFs borrow at the LIBOR rate (and even lower). When you factor in the hefty expense ratio, they begin to have similar costs to using futures (perhaps a little more expensive). These reset the leverage daily to achieve 2:1 leverage between every trading day. This makes these extremely susceptible to volatility decay but clearly superior during trending markets.
Can you please elaborate how LETFs can borrow below LIBOR rate, and what the evidence that they do so?
See viewtopic.php?p=4397820#p4397820 and viewtopic.php?p=4397820#p4397853
Reading your cited posts and the replies, the swaps were written at about LIBOR rates at the time when they were written, with the LIBOR applicable rates for the period until expiration. The "below libor" was an artifact of the LIBOR changes after they were written. One question is if swaps generally exhibit the roll richness that futures exhibit since a few years ago.

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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest » Tue Sep 10, 2019 3:43 am

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.
Since 1.77% is below the current risk-free rate of ca. 2%, something must be wrong with your math. I don't think any instrument can exist to borrow below the risk-free rate, as this would lead to arbitrage possibilities.
Some thoughts:
1. I think you assume 2% dividend rate. Is that number accurate, or an approximation? Also, did you account for expected increases in dividends over the 2.5 years?
2. When comparing to futures borrowing cost, you are comparing apples to oranges. Futures are rolled quarterly, i.e. you borrow for ca. 3 months. With your options, you borrowed for ca. 2.5 years. 2-year and 3-year treasuries yield ca. 1.5%. 3-month treasuries yield ca. 2%. This is an anomaly (inversion of yield curve) and is unlikely to last forever. Your 1.77% is indeed ca. 0.27% above the risk-free rate applicable to the term of the options, which is the only reasonable metric without making assumptions on, or trying to profit from, the slope of the yield curve.
3. SPY has an expense ratio of ca. 0.1%. I believe you are indirectly paying this when with your options strategy, and you would have to add that to you cost of leverage.

Adding everything together (except for dividends which I don't have data for), the cost of leverage seems to be very similar to that for futures. It seems like it would be expected that the options based synthetic futures position (adjusted for the respective LIBOR or risk-free rates based on duration) has a cost similar to that of the futures including futures roll richness, as otherwise it would be a free arbitrage opportunity for institutional investors.

Regarding simplicity and ease of execution: If I choose a good amount of cash cushion, I think a quarterly futures roll would cost me 3-5 minutes - symbols for the futures calendar spread (e.g. sell Sep / buy Dec expiration) are already supplied by the exchange, so the whole roll is essentially just one mouse click. To me, that seems faster than doing all the math and spreadsheets that you explained in your posts to select the optimal combination of options with the optimal expiration and strike price, even if you do that only every 2 years - how much of that do you expect to do every 2 years, and how much of the work can be reused?

Also, I'm not sure if I understood the risk of the put options being exercised. I understand you start out with a strike price at about the current spot price; but isn't it inevitable that the spot price will move away, with a high chance of it moving lower at some point during the 2.5 years, resulting in a high chance of being assigned if the counterparty is rational? Wouldn't this require permanent monitoring of your account? What would be the actions after assignment to bring the leverage back to where it was?

Regarding cost of leverage: IB pays interest on cash at 0.5% below the risk-free rate. If I were to choose a 30% cash cushion (including required margin) for futures, that would only very rarely require manual intervention between roll dates, my cost from the cash drag, with respect to the leveraged amount, would be 0.5% * 0.3 * (100 / 70) = 0.21%. (The 100/70 is an adjustment to reflect the fact that the futures notional value needs to also cover the cash cushion, but I want to see my cost of leverage as a percentage of the leveraged amount above 100% equity only, for easier comparison to alternate methods of leverage.) It appears that the nonsensical requirement that futures margin must be cash is an artificial profit generator for the brokerages.
If the risk-free rate goes back to near zero again in the future, that component of the leverage cost with futures would disappear. For futures on European and Japanese indexes, this component is currently zero.

I am intrigued by your options strategy, but for me, the future strategy still has an edge based on my current level of understanding.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Tue Sep 10, 2019 7:23 am

comeinvest wrote:
Tue Sep 10, 2019 3:43 am
Since 1.77% is below the current risk-free rate of ca. 2%, something must be wrong with your math.
I'm open to anyone pointing out errors in my math. I never claimed it was perfect 0_o That said, you seemed to answer this comment yourself any ways:
comeinvest wrote:
Tue Sep 10, 2019 3:43 am
With your options, you borrowed for ca. 2.5 years. 2-year and 3-year treasuries yield ca. 1.5%. 3-month treasuries yield ca. 2%. This is an anomaly (inversion of yield curve) and is unlikely to last forever. Your 1.77% is indeed ca. 0.27% above the risk-free rate applicable to the term of the options, which is the only reasonable metric without making assumptions on, or trying to profit from, the slope of the yield curve.
^ That seems reasonable. The 1.77% is fixed though so I am not worried that curve inversions are common or not. It seems I happened to enter this at a good time.
comeinvest wrote:
Tue Sep 10, 2019 3:43 am
1. I think you assume 2% dividend rate. Is that number accurate, or an approximation? Also, did you account for expected increases in dividends over the 2.5 years?
I assumed 1.97% dividend which was the S&P500 dividend yield at the time. I also assume a 5.3% increase in the dividend yearly (that's what I assume the nominal growth of the market will be, on average) and assume those dividends are immediately reinvested at the RFR once paid out. These 2nd and 3rd order effect considerations change the final borrowing value very little though.
comeinvest wrote:
Tue Sep 10, 2019 3:43 am
3. SPY has an expense ratio of ca. 0.1%. I believe you are indirectly paying this when with your options strategy, and you would have to add that to you cost of leverage.
If that's so, then it's already included in the 1.77% figure that is calculated from the option prices.
comeinvest wrote:
Tue Sep 10, 2019 3:43 am
Adding everything together (except for dividends which I don't have data for), the cost of leverage seems to be very similar to that for futures. It seems like it would be expected that the options based synthetic futures position (adjusted for the respective LIBOR or risk-free rates based on duration) has a cost similar to that of the futures including futures roll richness, as otherwise it would be a free arbitrage opportunity for institutional investors.
Yeah it should be close.
comeinvest wrote:
Tue Sep 10, 2019 3:43 am
Regarding simplicity and ease of execution: If I choose a good amount of cash cushion, I think a quarterly futures roll would cost me 3-5 minutes - symbols for the futures calendar spread (e.g. sell Sep / buy Dec expiration) are already supplied by the exchange, so the whole roll is essentially just one mouse click. To me, that seems faster than doing all the math and spreadsheets that you explained in your posts to select the optimal combination of options with the optimal expiration and strike price, even if you do that only every 2 years - how much of that do you expect to do every 2 years, and how much of the work can be reused?
Oh and if you include the reading of 3 different options books as well (some could even be considered textbooks frankly), the time investment is far higher. You can see it took me months from first hearing about the put-call parity to actually implementing something. Either way, it was a fun activity that I did in my off-time so I don't see it as cumbersome.

The simplicity advantage for me is that maintaining the position is fairly simple. I haven't checked on these options since I established the last set. I logged in just now to see and everything looks fine; I have about 3.3k of unrealized gains, which is what I expect. I don't have to ensure there's any cash cushions, I don't have to ensure paid out cash is invested, I don't have to follow market movements at all. It works for me but might not for others.

The spreadsheet is totally reusable and it takes me maybe 10 minutes to figure out a good set. That's a job for Dec 2021 though!
comeinvest wrote:
Tue Sep 10, 2019 3:43 am
Also, I'm not sure if I understood the risk of the put options being exercised. I understand you start out with a strike price at about the current spot price; but isn't it inevitable that the spot price will move away, with a high chance of it moving lower at some point during the 2.5 years, resulting in a high chance of being assigned if the counterparty is rational? Wouldn't this require permanent monitoring of your account? What would be the actions after assignment to bring the leverage back to where it was?
Everything you said is possible. Picking the strike price to match a Delta of 1.00 and Vega neutral (which is actually not necessarily the spot price with longer dated options) simply minimizes the possibility that either gets exercised early. These options have so much time value (I mean, they're basically ALL time value) that I am not worried this will occur any time soon. Of course if the market moves significantly, I will have to pay some attention.

I am not planning on getting assigned; once the put has lost enough time value that the possibility of assignment is very high, I would simply unwind the position and perhaps re-establish another one. We'll see how that goes.
comeinvest wrote:
Tue Sep 10, 2019 3:43 am
Regarding cost of leverage: IB pays interest on cash at 0.5% below the risk-free rate. If I were to choose a 30% cash cushion (including required margin) for futures, that would only very rarely require manual intervention between roll dates, my cost from the cash drag, with respect to the leveraged amount, would be 0.5% * 0.3 * (100 / 70) = 0.21%. (The 100/70 is an adjustment to reflect the fact that the futures notional value needs to also cover the cash cushion, but I want to see my cost of leverage as a percentage of the leveraged amount above 100% equity only, for easier comparison to alternate methods of leverage.) It appears that the nonsensical requirement that futures margin must be cash is an artificial profit generator for the brokerages.
I'm borrowing ~116k with options. If I did that in futures (say with some E micros), that would be ~35k in cash. IB doesn't pay a cent on the first 10k. So your additional cost might be more around 0.87%*0.3*(100/70) = 0.37%. And you'd pay taxes on that cash income too, at the high marginal tax bracket. That creates further drags.

The options allow your collateral in the form of tax-efficient ETFs, so I don't have to worry about this.

I found that the options (though most of their gains are ST CG) were very comparable to futures (with 60/40 tax treatment) in my particular circumstances, probably because the RFR in 2.5 years is much lower. But when you also factor in the tax and interest drags of the form your collateral needs to be in, options seemed to have a clear edge at IB. Perhaps it would be different at other places that do allow the entire cash cushion to be in T-bills, although I'd still worry about the tax paid on that interest as well as ensure the cash cushion gets invested in stocks once it grows enough or vice versa.

comeinvest wrote:
Tue Sep 10, 2019 3:43 am
I am intrigued by your options strategy, but for me, the future strategy still has an edge based on my current level of understanding.
Yes, I understand. Being comfortable with the strategy and math is very important! Good luck and let me know how it goes with you!

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Re: Lifecycle Investing - Leveraging when young

Post by hdas » Tue Sep 10, 2019 9:39 am

comeinvest wrote:
Mon Sep 09, 2019 11:58 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.

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
Can you cite an example of an FCM that allows T-Bills, or any other equity positions, as futures collateral? I asked a few, but have not been able to find one. Thanks!
I tell you 3 that I have used in the past:

>> RJO’Brien
>> Advantage Futures
>> FC Stone

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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Re: Lifecycle Investing - Leveraging when young

Post by HEDGEFUNDIE » Tue Sep 10, 2019 10:26 am

comeinvest wrote:
Tue Sep 10, 2019 3:08 am
HEDGEFUNDIE wrote:
Mon Sep 09, 2019 6:11 am
comeinvest wrote:
Mon Sep 09, 2019 3:27 am
305pelusa wrote:
Mon Aug 05, 2019 5:03 pm
...
- Leveraged ETFs: These ETFs borrow at the LIBOR rate (and even lower). When you factor in the hefty expense ratio, they begin to have similar costs to using futures (perhaps a little more expensive). These reset the leverage daily to achieve 2:1 leverage between every trading day. This makes these extremely susceptible to volatility decay but clearly superior during trending markets.
Can you please elaborate how LETFs can borrow below LIBOR rate, and what the evidence that they do so?
See viewtopic.php?p=4397820#p4397820 and viewtopic.php?p=4397820#p4397853
Reading your cited posts and the replies, the swaps were written at about LIBOR rates at the time when they were written, with the LIBOR applicable rates for the period until expiration. The "below libor" was an artifact of the LIBOR changes after they were written. One question is if swaps generally exhibit the roll richness that futures exhibit since a few years ago.
The spread is set at the time the swap is written; it’s a constant spread that is applied to LIBOR. So if the actual rate is below LIBOR at any point, you can assume that the spread was negative when it was set.

RandomWord
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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Tue Sep 10, 2019 12:58 pm

Is there any way to get historical data on options prices? Doesn't even have to be too far back, just from a few years ago when the yield curve wasn't inverted. I'd like to see whether comeinvest is right that the lower apparently cost of options leverage right now is due to duration and the yield curve being inverted. In other words, if we go back to a positive yield curve, we should see the (implied 2 year) interest rate of the option being higher than the (implied 3 month) interest rate of the futures contract.

But at a high level, what he's saying makes sense- there's no way options on a richly traded product like SPY would be below the risk free rate of return, or else some institutional investor [*]would[*] notice that and arbitrage it away. There has to be [*]some[*] catch in the math that you're missing, and the duration difference makes sense to me.

comeinvest
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest » Tue Sep 10, 2019 6:22 pm

HEDGEFUNDIE wrote:
Tue Sep 10, 2019 10:26 am
comeinvest wrote:
Tue Sep 10, 2019 3:08 am
HEDGEFUNDIE wrote:
Mon Sep 09, 2019 6:11 am
comeinvest wrote:
Mon Sep 09, 2019 3:27 am
305pelusa wrote:
Mon Aug 05, 2019 5:03 pm
...
- Leveraged ETFs: These ETFs borrow at the LIBOR rate (and even lower). When you factor in the hefty expense ratio, they begin to have similar costs to using futures (perhaps a little more expensive). These reset the leverage daily to achieve 2:1 leverage between every trading day. This makes these extremely susceptible to volatility decay but clearly superior during trending markets.
Can you please elaborate how LETFs can borrow below LIBOR rate, and what the evidence that they do so?
See viewtopic.php?p=4397820#p4397820 and viewtopic.php?p=4397820#p4397853
Reading your cited posts and the replies, the swaps were written at about LIBOR rates at the time when they were written, with the LIBOR applicable rates for the period until expiration. The "below libor" was an artifact of the LIBOR changes after they were written. One question is if swaps generally exhibit the roll richness that futures exhibit since a few years ago.
The spread is set at the time the swap is written; it’s a constant spread that is applied to LIBOR. So if the actual rate is below LIBOR at any point, you can assume that the spread was negative when it was set.
I assumed that a swap of duration (time until expiration / settlement) x would be based on the LIBOR rate for duration x (there are LIBORs for anything between 1 month and 12 months durations.) But even if the swaps of duration 1+ years are based on the 1-month libor, then the spread would probably reflect the expected future changes in the 1-month libor rate until expiration, and/or the spread differential between shorter-term and longer-term LIBORs. In either case, based on a no-arbitrage hypothesis and if the counterparty doesn't give away free money, it would be fair to assume that in the long run, the cost of leverage will be at least LIBOR, or rather LIBOR plus the equivalent of the current futures spread to LIBOR, wouldn't it?

comeinvest
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest » Tue Sep 10, 2019 6:31 pm

hdas wrote:
Tue Sep 10, 2019 9:39 am
comeinvest wrote:
Mon Sep 09, 2019 11:58 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.

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
Can you cite an example of an FCM that allows T-Bills, or any other equity positions, as futures collateral? I asked a few, but have not been able to find one. Thanks!
I tell you 3 that I have used in the past:

>> RJO’Brien
>> Advantage Futures
>> FC Stone

Cheers :greedy
Thank you, I really appreciate it. Do you happen to know if there are any futures brokers that allow any equities or ETFs as collateral? I think a while ago I read in some futures regulatory publication that various assets can serve as futures collateral at different percentages of current value, but the regulations are hard to decipher and to interpret, and it appears that institutional parties get conditions different from individuals. I would be glad if you could share any insight. T-Bills are better than interest-free cash, but I'd rather not invest in T-Bills if I can avoid it. Also, there is constant monitoring and work involved with rolling T-Bills, or not?

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Tue Sep 10, 2019 6:48 pm

RandomWord wrote:
Tue Sep 10, 2019 12:58 pm
Is there any way to get historical data on options prices? Doesn't even have to be too far back, just from a few years ago when the yield curve wasn't inverted. I'd like to see whether comeinvest is right that the lower apparently cost of options leverage right now is due to duration and the yield curve being inverted. In other words, if we go back to a positive yield curve, we should see the (implied 2 year) interest rate of the option being higher than the (implied 3 month) interest rate of the futures contract.

But at a high level, what he's saying makes sense- there's no way options on a richly traded product like SPY would be below the risk free rate of return, or else some institutional investor [*]would[*] notice that and arbitrage it away. There has to be [*]some[*] catch in the math that you're missing, and the duration difference makes sense to me.
I looked into this a bit some time ago but it looked like most places charge you. Kind of interesting since the information was free at some point haha.

Three things to keep in mind:
1) I did find that the longer the duration, the cheaper the rate. So to the extent that the curve is inverted, option prices seemed to reflect that.
2) Arbitraging with American options is not necessarily perfect. The early exercise clause makes it so it's not necessarily trivial to arbitrage options far away from the strike price. This is not a problem with European options which, in fact, can have negative time value. This capping of the value of the options can skew things to the point where American options might actually look like a free arbitrage lunch if somehow you were not assigned until expiration.

That's to say: It's possible math on these options might reveal positions that look like free lunches, borrowing at below RFR and what not. But that's only because your math is not taking into account potential early exercise; mine certainly isn't.

3) The market of LEAPs on the SPY is not particularly strongly traded. Bid-ask spreads are fairly large for many. Some options have ridiculous implied volatilities (like 70+%), which means it would be a no-brainer to sell these. I can only speculate that arbitrageurs and hedge funds do not do this because the spreads alone consume that profit.

^This last point is not very relevant since I am taking the spread into account (as any one should) but if all you look at is the mid-way price (as options chains might show), some of these look like obvious scores. I can only assume it's because the lack of trading creates these seeming pockets of inefficiency that cannot be exploited due to the spread.

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Re: Lifecycle Investing - Leveraging when young

Post by hdas » Wed Sep 11, 2019 12:56 pm

comeinvest wrote:
Tue Sep 10, 2019 6:31 pm

Thank you, I really appreciate it. Do you happen to know if there are any futures brokers that allow any equities or ETFs as collateral? I think a while ago I read in some futures regulatory publication that various assets can serve as futures collateral at different percentages of current value, but the regulations are hard to decipher and to interpret, and it appears that institutional parties get conditions different from individuals. I would be glad if you could share any insight. T-Bills are better than interest-free cash, but I'd rather not invest in T-Bills if I can avoid it. Also, there is constant monitoring and work involved with rolling T-Bills, or not?
Wait, imagine the constant monitoring with the more volatile equities as collateral !!

Rolling T-Bills is a trivial task, just email your broker. The brokers I mentioned to you have a representative available for you.....the commissions are proportional to the business you bring to the tho.

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 Sep 11, 2019 4:42 pm

These past few weeks are an excellent example of why I make a big deal of maintaining exposure instead of constant leverage.

As the market dipped, my leverage increased slightly. A pay period came by and I was able to erase some of those losses, effectively buying right at the market bottom (~28400). Now the market has gone right back up, getting me right back to my lifetime equity targets. So this new paycheck was actually my first time repaying some of my debt. It felt good to put in that 2k towards debt and deleverage.

If you used constant leverage, you would've sold at the market bottom instead of bought (first strike). You would then not get back to even as the market came back up since you sold shares, aka volatility drag(second strike). And finally, instead of putting money from your paycheck into your debt precisely when the market is higher, you'd actually be buying shares right now (third strike).

If you want to diversify temporally, I think picking a modest amount of leverage that minimizes the possibility of selling at the bottom (unlikely any ways if you're in early accumulation) is superior to a large amount of constant leverage.

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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Wed Sep 11, 2019 5:21 pm

305pelusa wrote:
Wed Sep 11, 2019 4:42 pm
These past few weeks are an excellent example of why I make a big deal of maintaining exposure instead of constant leverage.

As the market dipped, my leverage increased slightly. A pay period came by and I was able to erase some of those losses, effectively buying right at the market bottom (~28400). Now the market has gone right back up, getting me right back to my lifetime equity targets. So this new paycheck was actually my first time repaying some of my debt. It felt good to put in that 2k towards debt and deleverage.

If you used constant leverage, you would've sold at the market bottom instead of bought (first strike). You would then not get back to even as the market came back up since you sold shares, aka volatility drag(second strike). And finally, instead of putting money from your paycheck into your debt precisely when the market is higher, you'd actually be buying shares right now (third strike).

If you want to diversify temporally, I think picking a modest amount of leverage that minimizes the possibility of selling at the bottom (unlikely any ways if you're in early accumulation) is superior to a large amount of constant leverage.
I think this is a matter of trending vs mean-reverting markets. If the market had continued to trend down, you'd have been better off selling as it went (constant leverage). "Buy the dip" looks great, until it stops working.

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Re: Lifecycle Investing - Leveraging when young

Post by HEDGEFUNDIE » Wed Sep 11, 2019 5:33 pm

RandomWord wrote:
Wed Sep 11, 2019 5:21 pm
305pelusa wrote:
Wed Sep 11, 2019 4:42 pm
These past few weeks are an excellent example of why I make a big deal of maintaining exposure instead of constant leverage.

As the market dipped, my leverage increased slightly. A pay period came by and I was able to erase some of those losses, effectively buying right at the market bottom (~28400). Now the market has gone right back up, getting me right back to my lifetime equity targets. So this new paycheck was actually my first time repaying some of my debt. It felt good to put in that 2k towards debt and deleverage.

If you used constant leverage, you would've sold at the market bottom instead of bought (first strike). You would then not get back to even as the market came back up since you sold shares, aka volatility drag(second strike). And finally, instead of putting money from your paycheck into your debt precisely when the market is higher, you'd actually be buying shares right now (third strike).

If you want to diversify temporally, I think picking a modest amount of leverage that minimizes the possibility of selling at the bottom (unlikely any ways if you're in early accumulation) is superior to a large amount of constant leverage.
I think this is a matter of trending vs mean-reverting markets. If the market had continued to trend down, you'd have been better off selling as it went (constant leverage). "Buy the dip" looks great, until it stops working.
And as we know, in the long run the markets trend up.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Sep 11, 2019 5:52 pm

RandomWord wrote:
Wed Sep 11, 2019 5:21 pm
305pelusa wrote:
Wed Sep 11, 2019 4:42 pm
These past few weeks are an excellent example of why I make a big deal of maintaining exposure instead of constant leverage.

As the market dipped, my leverage increased slightly. A pay period came by and I was able to erase some of those losses, effectively buying right at the market bottom (~28400). Now the market has gone right back up, getting me right back to my lifetime equity targets. So this new paycheck was actually my first time repaying some of my debt. It felt good to put in that 2k towards debt and deleverage.

If you used constant leverage, you would've sold at the market bottom instead of bought (first strike). You would then not get back to even as the market came back up since you sold shares, aka volatility drag(second strike). And finally, instead of putting money from your paycheck into your debt precisely when the market is higher, you'd actually be buying shares right now (third strike).

If you want to diversify temporally, I think picking a modest amount of leverage that minimizes the possibility of selling at the bottom (unlikely any ways if you're in early accumulation) is superior to a large amount of constant leverage.
I think this is a matter of trending vs mean-reverting markets. If the market had continued to trend down, you'd have been better off selling as it went (constant leverage). "Buy the dip" looks great, until it stops working.
Say the market drops and continues to drop. Two things will happen eventually:
1) The market eventually gets back to the pre-crash level.
2) The market never gets back up to the pre-crash level.

In the case of #1, no matter what happens, the person that does not sell will come out ahead. It is path independent, just like B&H. I happen to believe the market will recover from its absolute worst possible decline within my 50 year investment horizon. If I didn't think so, then I might consider trend-following or any other strategies that depends on the path the market takes.


The opposite occurs if the market rises. As a market rises, two things will happen over your horizon:
1) The market will dip back to the initial price point.
2) The market never again reaches that low.

If 1 occurs, constant leverage will always outperform. Here's the key part though: I'm OK with that one. Lifecycle Investment is not about making the most profitable portfolio; it is about minimizing risk for me personally.

So I am perfectly ok leaving gains on the table that could be realized by trending up markets. As long as I can avoid the additional losses from constant leverage due to down markets. I know that's difficult to get since everyone keeps talking about constant leverage's superiority in down markets but once you frame it in a multi-decade period, B&H always outperforms any strategy that sells at any point below the future price point. And Lifecycle Investment with variable leverage is the equivalent of B&H for leveraged strategies.

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Re: Lifecycle Investing - Leveraging when young

Post by UberGrub » Thu Sep 12, 2019 10:54 am

305pelusa wrote:
Wed Sep 11, 2019 4:42 pm

If you want to diversify temporally, I think picking a modest amount of leverage that minimizes the possibility of selling at the bottom (unlikely any ways if you're in early accumulation) is superior to a large amount of constant leverage.
If I understand correctly from reading the book, the point of temporal diversification is to have a similar real dollar value invested in the market throughout your life to spread out the risk evenly into as many stock years as possible. You "bet equally" on every year.

If you use constant leverage, the above is assured to not happen. After a bad year, your exposure would be reduced for the next period. After a good year, your exposure would be increased for the next period. This is the opposite of "constant exposure". You'd bet more on the years after the good ones and bet less on the years after the bad ones.

If I understand the theory correctly, constant leverage does not lead to temporal diversification. So it's not that variable is better than constant leverage; it is simply that the first one achieves temporal diversification while the latter avoids it.

If you want to diversify temporal, it appears only the former even accomplishes it at all.

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Re: Lifecycle Investing - Leveraging when young

Post by HEDGEFUNDIE » Thu Sep 12, 2019 11:04 am

305pelusa wrote:
Wed Sep 11, 2019 5:52 pm
If 1 occurs, constant leverage will always outperform. Here's the key part though: I'm OK with that one. Lifecycle Investment is not about making the most profitable portfolio; it is about minimizing risk for me personally.

So I am perfectly ok leaving gains on the table that could be realized by trending up markets.
Different strokes for different folks.

I prefer more money to less money, personally.

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Re: Lifecycle Investing - Leveraging when young

Post by UberGrub » Thu Sep 12, 2019 12:22 pm

HEDGEFUNDIE wrote:
Thu Sep 12, 2019 11:04 am
305pelusa wrote:
Wed Sep 11, 2019 5:52 pm
If 1 occurs, constant leverage will always outperform. Here's the key part though: I'm OK with that one. Lifecycle Investment is not about making the most profitable portfolio; it is about minimizing risk for me personally.

So I am perfectly ok leaving gains on the table that could be realized by trending up markets.
Different strokes for different folks.

I prefer more money to less money, personally.
That seems very unfair to say. You're barely leveraged; only a fraction of your portfolio is in LETFs.

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Re: Lifecycle Investing - Leveraging when young

Post by RandomWord » Thu Sep 12, 2019 1:22 pm

305pelusa wrote:
Wed Sep 11, 2019 5:52 pm
RandomWord wrote:
Wed Sep 11, 2019 5:21 pm
305pelusa wrote:
Wed Sep 11, 2019 4:42 pm
These past few weeks are an excellent example of why I make a big deal of maintaining exposure instead of constant leverage.

As the market dipped, my leverage increased slightly. A pay period came by and I was able to erase some of those losses, effectively buying right at the market bottom (~28400). Now the market has gone right back up, getting me right back to my lifetime equity targets. So this new paycheck was actually my first time repaying some of my debt. It felt good to put in that 2k towards debt and deleverage.

If you used constant leverage, you would've sold at the market bottom instead of bought (first strike). You would then not get back to even as the market came back up since you sold shares, aka volatility drag(second strike). And finally, instead of putting money from your paycheck into your debt precisely when the market is higher, you'd actually be buying shares right now (third strike).

If you want to diversify temporally, I think picking a modest amount of leverage that minimizes the possibility of selling at the bottom (unlikely any ways if you're in early accumulation) is superior to a large amount of constant leverage.
I think this is a matter of trending vs mean-reverting markets. If the market had continued to trend down, you'd have been better off selling as it went (constant leverage). "Buy the dip" looks great, until it stops working.
Say the market drops and continues to drop. Two things will happen eventually:
1) The market eventually gets back to the pre-crash level.
2) The market never gets back up to the pre-crash level.

In the case of #1, no matter what happens, the person that does not sell will come out ahead. It is path independent, just like B&H. I happen to believe the market will recover from its absolute worst possible decline within my 50 year investment horizon. If I didn't think so, then I might consider trend-following or any other strategies that depends on the path the market takes.


The opposite occurs if the market rises. As a market rises, two things will happen over your horizon:
1) The market will dip back to the initial price point.
2) The market never again reaches that low.

If 1 occurs, constant leverage will always outperform. Here's the key part though: I'm OK with that one. Lifecycle Investment is not about making the most profitable portfolio; it is about minimizing risk for me personally.

So I am perfectly ok leaving gains on the table that could be realized by trending up markets. As long as I can avoid the additional losses from constant leverage due to down markets. I know that's difficult to get since everyone keeps talking about constant leverage's superiority in down markets but once you frame it in a multi-decade period, B&H always outperforms any strategy that sells at any point below the future price point. And Lifecycle Investment with variable leverage is the equivalent of B&H for leveraged strategies.
Yeah, on reflection I think this is right. The real catch is the risk of losing so much money that you go broke or get hit with a margin call. You can't make up the losses if you were forced to sell at the bottom, even if the market eventually went back up. Well that, and controlling your emotions during a big crash, which is a real issue that shouldn't be overlooked.

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